Invested in mutual funds but not knowing exactly which type of mutual fund suits to you? This blog post is then for you, which explain various types of mutual funds in detail.
In the early days of investing, many investors must have experienced the journey of investing through certain types of mutual funds. Mutual funds prove to be a simple and relatively safe investment tool when it comes to investing.
There are several types of mutual funds proposed for different purposes that suit to different investors according to their objectives. This article explains different types of mutual funds and their benefits for investors.
Initially, the investor should understand that any mutual fund is investing in either equity or debt. Some mutual funds invest in both equity and debt, which are also known as hybrid mutual funds.
Equity or stock means the ownership of investor in a company and it can traded on the stock exchange.
In simple language, equity means ownership of assets after the debt is paid off. Debt is money that is borrowed by one person/company from others. Debt is used by many companies for building their business or expansion. Borrower have to return this money after fixed time with some interest
So some mutual funds invests money in stocks of companies (equity mutual funds) while some invests in debt instruments such as treasury bills, corporate bonds, commercial papers and government securities (debt mutual funds). Return on debt mutual fund is fixed whereas return on equity mutual funds are subjected to market conditions.
Further, mutual fund can be open-ended type or close-ended type.
In open ended scheme, an investor can purchase or sale his units at any point of time. In other words, open ended mutual funds does not have a any kind of locking period and investor is free to enter or exit from it.
Close-ended mutual funds, on the other hand, have a certain maturity period. Once the NFO (New Fund Offer) is launched, the investor can purchase units in a close ended scheme.
At the maturity time, this investment will automatically be redeemed. In other words, an investor has to put his money locked for fixed time frame and have to wait for maturity.
Hybrid mutual funds which invests in both equity and debt, can be either equity oriented hybrid fund or debt oriented hybrid funds, depending on higher allocation in equity or debt respectively.
Types of Equity mutual funds
So exactly how many types of mutual funds are there for investors?
Equity mutual funds are classified as Large cap funds, Mid cap funds and Small cap funds.
This classification is done according to Market Capitalization of companies.
Equity funds are popular mutual fund schemes which allow investors to invest their money in stock markets. Equity funds has potential to get high return in spite of high risk in long run. Equity mutual funds are suitable to young investors who are in their early earning stage, looking to building a good portfolio for long run.
Equity funds further can be categorized into following types based on strategy adopted to manage the fund.
- Passive and active funds
- Diversified equity funds
- Based on segment of market
- Based on sectors
- Theme based
- Based on investment style
- ELSS equity funds
- Passive and active funds: Passive funds invests money in only those companies who are in index (such as Nifty or Sensex in India) in the same proportion as the company’s representation in an index. Active funds select any stocks which fund manager think able to give higher return than index.
- Diversified equity funds: They invests across segments, sectors and sizes of companies.
- Based on segment of market: Equity mutual funds may be classified as Large cap funds, Mid cap funds and Small cap funds. This classification is done according to Market Capitalization of companies. Large cap funds invests in large, blue chip companies while mid cap funds invests in potential companies for faster growth and higher returns. Small cap funds however invests in companies with small market capitalization. With possible high benefit, the risk is also higher in these.
- Based on sectors: These funds invest in companies that belong to particular sector such as Banking, Technology etc.
- Theme based: Theme based funds invest in multiple sectors that form a particular theme. Example is infrastructure, where fund manager invests money in companies of construction, cement, banking, logistics etc to form a theme. Though these funds are more diversified than sector funds, still carries high concentration risk.
- Based on investment style: Fund manager may adopt particular strategy to manage fund’s portfolio. Growth funds, Dividend yielding funds or value funds may put under this heading.
- ELSS funds: These are special type of equity fund which give the investor tax deduction benefits under section 80C of Indian income tax upto limit of Rs 1,50,000 per year. There is locking period of three years for ELSS funds.
Types of Debt mutual funds
Debt funds can be categorized based on securities they hold.
Short term debt fund: These consist of
- Money market fund or liquid funds
- Ultra short term plans
- Short term plans
Money market or liquid funds are very short term maturity. They usually invests in debt securities which have maturity less than 90 days. Their primary source of income is interest income. Liquid funds provides safety of principal and good liquidity.
Ultra short term funds which are also known as treasury management funds or cash management funds. They invests in money market and other short term securities of maturity up to 365 days.
Short term plans are the funds who combines short term debt securities with small allocation to longer debt securities.These plans earns interest income from short term securities and interest as well as capital gain from long term securities.
Long term debt funds are of following types.
- Income fund
- Gilt funds
- Dynamic debt funds
- Floating rate funds
- Fixed maturity plans (FMP)
- Income funds: These funds invests in short and long term debt securities with a objective to generate income.
- Gilt funds: These funds invests in government securities of medium and long term maturities.
- Dynamic debt funds: These funds seek dynamic management of interest rate risk and credit risk. In other words, these funds have no restrictions with respect to security types or maturity profiles that they invest in.
- Floating rate funds: These funds invests primarily in floating rate debt instruments.
- Fixed maturity plans: These are close end funds that invests in debt securities with maturities that match the term of the scheme.
- Debt oriented hybrid funds
- Equity oriented hybrid funds
- Debt oriented hybrid funds: These funds invest minimum of 70-95% in a debt portfolio. The debt portfolio is managed with focus of generating regular income.
- Equity oriented hybrid funds: These funds invest in the equity market, but invest up to 35% in debt. These funds typically have an asset allocation of 65-80% in equity and 20-35% in debt.
So an investor can choose a mutual fund from above types of mutual funds which suits to his goal and time horizon.