Now Mutual Funds have become a very easy and attractive way to invest in the equity market for Indian investors. The recent data has shown that inflows into MFs have reached all time high. Here we will take you through the different kinds of fund and more.
Laila: I am new investor and would like to know more about the kinds of Mutual funds?
Rekha: Mutual Funds are an excellent choice for new investors and for those who do not have the time to study companies’ performance and invest directly.
In Mutual funds, the fund manager will select the stocks to invest in and you will receive the Net Asset Value (NAV) for the money invested. We can broadly divide it into Debt fund schemes, Equity fund schemes.
Laila: Please tell me first about Equity fund schemes.
Rekha: Funds that invest in equity shares are called equity funds. They are:
Equity-oriented hybrid funds. These schemes invest in a mix of equity (at least 65 per cent of the corpus) and debt. We can say that they are less volatile than pure equity funds because of the mixed portfolio. The debt investments provide stability in times of volatility. These funds are suitable for new stock investors and very conservative equity investors.
Largecap funds, as the name suggests invest mainly in big companies.
The companies these Funds invest in are based their market capitalization and are well-established players and leaders in their respective filed. Therefore they these funds are considered safe to invest and are ideal for conservative equity investors. They carry relatively less risk and deliver modest returns.
Diversified funds on the other hand invests across different market capitalisations. So there will be a mix of large cap companies and mid and small cap, depending on the view of the fund manager. As it has a mix of companies, they are more risky than a Large cap fund, but less when compared with mid and small cap funds.
These are suitable if you have a modest risk appetite.
Mid cap funds invest mostly in medium-sized companies. Now, the performance of these companies will definitely be watched by the fund managers, but it has more risk associated with it. The potential of these companies to become large cap makes them attractive. If the companies perform well then the fund will deliver superior returns. So if you are prepared to take a higher risk then you can bet on these funds.
Small cap funds invest in small companies. Many of these companies have great potential but as there could be very little public information about them, it would be hard to analyse. These companies can be extremely risky, as there will be very little information about them available in the public domain. However, many small cap funds have offered excellent returns. They are ideal for investors who have a very high risk appetite.
Sector funds invest mostly in a particular sector or are theme based. They are considered risky as the returns depend on the performance of the particular sector the fund invests in. Those investing in these funds will have to monitor their investments and watch the sector as well.
Equity Linked Savings Schemes or tax planning mutual funds are suitable for investors looking to save taxes under Section 80 C of the Income Tax Act. Investments in these funds qualify for a tax deduction of up to Rs 1.5 lakh. They come with a mandatory lock-in period of three years.
Arbitrage funds are not exactly equity funds as they don’t invest in equity. They are treated as equity schemes for taxation purpose. These funds are relatively safer and provide tax free returns if held for a year or more. They look to exploit price difference between the cash and derivatives markets to generate returns. These are ideal for conservative investors who are looking for almost steady returns, like in debt fund with low risk and added tax benefits.
Laila: Thank you Rekha. Now what about Debt fund schemes?
Rekha: Liquid Funds invest in highly liquid money market instruments. They invest in securities with a residual maturity of not more than 91 days. Investors can park money in them for a few days to few months.
Ultra Short-Term Funds invest mostly in very short-term debt securities and a small portion in longer-term debt securities. Investors can park their short-term surplus for a few months to a year in these funds.
Fixed Maturity Plans are closed-ended debt mutual funds that invest in debt instruments with less than or equal to the maturity date of the scheme. Securities are redeemed on or before maturity and proceeds are paid to the investors. FMPs are a good alternative to fixed deposits for investors in the higher tax bracket.
Short-Term Funds invest mostly in debt securities with an average maturity of one to three years. They perform well when short term interest rates are high. They are suitable to invest with a horizon of a few years.
Dynamic Bond Funds invest across all classes of debt and money market instruments with varying maturities. These funds have an actively-managed portfolio. Bond Prices are inversely proportional to interest rates, so they have the highest capital gains potential when rate cycles are at their peaks or near peaks. Additionally, longer duration bonds are far more price-sensitive to changes in rates that vary dynamically with the interest rate view of the fund manager. They are ideal for investors who want to leave the job of taking call on interest rates to the fund manager.
Income Funds are debt mutual funds that invest in a combination of government securities, certificates of deposits, corporate bonds and money market instruments with long maturities. They are highly vulnerable to the changes in interest rates. They are suitable for investors who are ready to take high risk and have a long term investment horizon. The right time to invest in these funds is when the interest rates are likely to fall.
Gilt Funds invest in government securities. They do not have the default risk because the bonds are issued by the government. However, they are highly vulnerable to the changes in interest rates and other economic factors. These funds have high interest rate risk. Invest with a long-term horizon.
Debt-oriented hybrid funds , as the name suggests, invest mostly in debt and a small part of the corpus in equity. The equity part of the portfolio would provide extra returns, but the exposure also makes them a little risky. Invest with a horizon of three years or more.
Posted: October 2017