Introduction: Every person in the world will be with some financial goals like owning a house, plan for foreign trip, accumulating money for children education and marriage etc., and based on this each plans in different way to save money, but many of them will fail to achieve goals at final. This is because dumping money in less return yielding instruments and not even beating inflation at some times. This is the time to realize proper investing and reaching goals at right time.
Mutual fund is an investment weapon and is best among all strategies to invest money as every fund is managed by a professional with careful study. Recent studies and surveys are showing increases in participation of retail investors in Mutual funds. This is estimated that today more than half of American households invest in mutual funds.
Mutual fund industry in India started in year 1963 with the formation of Unit Trust of India (UTI) at the initiative of Reserve Bank of India (RBI) and Indian Government. The main objective for introducing a mutual funds system is to encourage more retail customers into market investment thereby increasing in GDP of the country.
There are more than 2000+ primary mutual fund schemes in India say for SBI Magnum MultiCap Fund, UTI Multi Cap Fund, Kotak Equity Opportunities Fund etc., if we include their variants like: Growth, Dividend it would all come to 20k + schemes. The company that puts together all mutual funds is called an Asset Management Company (AMC). Each scheme has similar or varied investment objectives and these are laid down in the fund’s prospectus, which is the legal document that contains information about the fund, history, officers and performance.
The AMC recruits a professional fund manager, who buys and sells securities in guide lines with that of the fund’s stated objective. All AMC’s are regulated by Securities and Exchange Board of India (SEBI) and funds governed by the Board of Directors.
Each investor owns a unit, which represents a portion of the holdings of the fund and it is represented as NAV (Net Asset Value) units. Investors make money in two ways:
- Income earned from dividends
- Appreciation in the NAV
Types of Mutual funds:
No matter what type of investor you are, there is a wide variety of mutual funds that fits your taste. It is important to understand that each mutual fund has a different risk and reward profile. Mutual fund is the concept that exactly fits Warren buffet quote –
Don’t Put All Eggs in One Basket
Most of the funds since inception gave good returns to that of benchmark. The higher the return, higher the risk of potential loss. Each mutual fund has predetermined investment objectives and rules that help the investor to choose the type of fund based on one’s greed. The risk aspects underlying these funds and sustainability gave rise to different types and designed to meet varying needs of investors. One who is willing to take higher risk tends to choose equity funds and who tends for lower risk will opt for Debt funds. The longer the investment horizon will be better to choose equity funds and with that of short to medium choose debt and balanced funds.
Investors are given with entry and exit options as per their choice like:
- Open-ended funds: Mutual fund units are bought and sold at any time at their NAV which is calculated at the close of every trading day. NAV varies with the purchase and redemption transactions and also with the change in underlying stocks price.
- Closed-ended funds: Investors can buy units of a closed-ended scheme from the fund only during its NFO and will have fixed maturity e.g. 3 years. SEBI made a mandatory rule for all closed ended funds to be listed on stock exchanges.
- Interval funds: It is a combination of both open ended and closed ended schemes. They are mostly closed ended, but become open ended at pre-specified intervals, say for e.g. open ended between Jan 1 to 15, July 1 to 15.
Categorization of Products:
- Keeping in mind the investor’s greed and investment strategies fund managers of different AMC offer mutual funds in the range of Equity, Debt and Hybrid. Mutual fund is thus created with a proper definition to allocate funds in specific securities and investment objectives. Based on the objective, time horizon and risk appetite investors tend to choose and pool money into a particular mutual fund product.
- Equity funds: These schemes are designed to pool amounts into stocks. Equity funds have a higher degree of risk and return in the same proportion. However the risk levels differ with that of investment strategies adopted by the fund managers. Equity can be classified into aggressive, diversified, sector specific and thematic Each type is designed with specific strategy and objectives, Diversified funds can invest in broad equity markets, without any restrictions and have lower risk compared to that of specific sector equity funds examples: HDFC Equity Fund, AXIS Equity Fund.
Large Cap Funds: The section of funds that pool amount on the equity shares of large sized companies. Large cap companies are usually with good fundamentals and the shares are easy to buy and sell in the market. Large cap companies have lower risk with good track record and history examples: ICICI Pru top 100 Fund, DSPBR Top 100 equity.
Mid Cap Funds: These are funds that focus on equity shares of medium sized companies. These are usually the second focused companies in the market and bought for their potential to grow in earnings and profitability and become big. Risk of failures, especially during the turn in business cycles, can also be high examples: ICICI Pru Midcap fund, Axis Midcap fund.
Small Cap Funds: These are funds that focus on equity shares of small companies, many of them typically new and upcoming companies. They are bought for their future potential, but they can be difficult to buy and sell in large quantities. The risk of selection is high as many companies in this segment fail to grow and establish business as expected examples: SBI Small and Midcap fund, DSPBR Small and Midcap.
Thematic & Sector Funds: These are funds that focus on companies in a particular theme such as infrastructure/ banking/FMCG etc., All the companies in such schemes belong to one particular sector and the fund performance depends upon sector growth examples: UTI Banking sector, SBI Pharma fund, ICICI Pru FMCG fund.
Diversified Equity Fund: These funds are specially designed to protect the capital and to get better returns when compared to that of investing in particular sized or sectoral companies. Invested corpus is diversified according to stock performance and yields better returns .Diversification of funds prevents huge losses in critical situations and helps to be relaxed at all time examples: DSPBR Opportunities fund, SBI Magnum Multicap fund.
- Debt funds: Debt funds are classified into 2 types as Short term (money market securities) and long term securities (bonds and debentures). Debt funds have very low risk with fixed term specific rate of interest. Debt Securities have fixed term and longer debt securities have a potential to pay a higher rate of interest. The value of debt securities goes up and down that fluctuates with that of the interest rates. There is also categorization based on default risk and usually denoted by credit rating. A debt security with a higher credit rating like AAA, has lower risk of default than say, BBB rating.
Liquid or Money Market Funds: These are classified as very short term funds and funds are invested in short term debt instruments with less than 91 days such as treasury bills, commercial papers and certificate of deposits. Liquid funds are safe with principal and liquidity as the risk of NAV fluctuation is low examples: India bulls liquid fund
Short Term Debt Funds: These are with slightly longer term than liquid funds and returns from these funds are income earned from coupons. As the tenor of bonds is longer the scope to earn capital gains examples: ICICI Pru Short Term Fund, Reliance Short Term Fund.
Income Funds: Debt funds predominantly invest in a wide range of medium term and long term debt instruments issued by companies, banks and financial institutions. They pay a higher interest rate as they do invest in long term securities and probably with higher risk to that of gilt funds as these securities are non-government agencies that may carry the risk of default. These funds mainly provide regular income rather than capital appreciation examples: Reliance Income Fund.
Gilt Funds: These funds are same to that of Income funds but with the corpus invested only in government medium term and long term securities. So these are risk free and get higher return depending on tenor of the scheme examples: ICICI Pru Gilt Fund.
Floating Rate Funds: Name of the fund itself states that the rate of return is not fixed and completely varies with that of the market benchmark. Floating also invests in class of debt instruments whose interest rates are not fixed examples: Templeton India Floating Rate Fund.
High-yield Debt Funds: Debt funds with higher default risk as they do invest in funds which pay a higher interest rate of lower credit rating debt instruments. These are also called Junk funds.
Fixed maturity plans (FMPs): Fixed Maturity Plans are closed ended funds with fixed interest rate and corpus invested in debt instruments for a tenor ranges from 91 days to 5 years. Most commonly they come with maturity periods of 91 days, 190 days, 390 days, and 750 days and more. New schemes are started once the existing scheme tenor is completed.
- Balanced or Hybrid funds: It’s a mixture of investment in both stocks and bonds with proper ratio.
The main objective of these funds is to provide better returns with capital appreciation by investing corpus in both equity and debt in appropriate ratios according to the market conditions. The scheme provides clear info on the ratio of investment in equity and debt in their documentation. Mostly balanced funds will have a weighting of equity to debt is 60-40 or 50-50 or 70-30 and this ratio is restricted to specified maximum and minimum for each asset class and helps in rebalancing the portfolio in case of worst and better situations examples: HDFC balanced fund.
Apart from these types there are many other types of funds, like:
- Index funds invest in indexes like nifty, sensex etc
- Foreign security funds invest in securities of other markets and also called international funds.
- Commodity funds invest in commodities companies which deal with precious metals, edible oils and grains etc as Indian markets don’t have permission directly to invest in commodities.
- Real estate funds invest in real estate directly or lend to real estate developers or buy securities of housing companies and sectors related to housing and property.
- Fund of Funds (FoF) invest in other mutual funds.
- Exchange Traded Funds (ETF) are also mutual funds but they are traded and listed on exchanges. These are linked to underlying indices, commodities such as Gold and NAV get changed with the performance of underlying indices. Say for example gold ETF with 99.5% purity and allows the investors to buy gold in quantities as low as 1 gm which is done in demat form and each gram represents 1 unit. The units of ETF first available in the NFO will be based on the NAV of the scheme.