Mutual funds are specifically designed for the community, as mentioned above. Multiple investors want to enjoy the joys of compounding by investing in financial markets but might not have the time or financial know-how to proceed with the same. Mutual funds pool money from various such investors and invest the collected corpus in different investment avenues based upon the fund’s overall objective. The fund managers manage the day-to-day functioning of the investments, making decisions upon the buying and selling of the investments depending upon the objectives of the funds.
Categories of Mutual Funds:
The SEBI guidelines on Categorization and Rationalization of schemes were issued in October 2017. According to that, the mutual fund schemes are classified below:
1. Equity Schemes:
These mutual fund categories primarily invest the pooled fund into equity and equity-related instruments. The objective of such schemes is to gain long-term capital appreciation through their investments. These funds are suitable for investors with a higher risk appetite and a longer-term investment horizon.
The categorization for the same can be based upon market capitalization: Large Cap Fund (80% of investment in large-cap stocks), Mid Cap Fund (65% investment in mid-cap stocks), Small Cap Fund (65% of investments in small-cap stocks). The funds can also be based upon a Multi-Cap Fund strategy wherein the fund managers can curate their funds based upon allocations in multiple market capitalization.
The categorization of funds can also be based upon the investment strategy. Growth funds invest predominantly in companies aggressively aiming to increase their sales and try to capture the maximum market capitalization possible. Value funds invest in stocks undervalued relative to their sector or the overall equity market. Dividend Yield funds invest predominantly in stocks that give out a significant amount of their earnings in the form of dividends. Investors with lesser risk appetite invest in such funds as the companies included in these funds generally have a proven track record and significant market leaders.
The funds can also be based upon a particular sector or a theme like metal, banks, or automobiles, to name a few. Such funds have 80% investments into their theme-based equity investments.
2. Debt Schemes:
These debt mutual funds invest in short and long-term securities issued by the government, companies, and public financial institutions in the form of Treasury Bills, Government Securities, Debentures, Commercial Paper, Certificates of Deposit, and many more debt instruments. These mutual fund categories primarily invest the pooled fund in bonds or other debt securities. Investors ideally prefer these debt funds for income generation and preservation of capital.
The duration of the debt instruments can categorize these funds. These debt instruments can have maturities as short as one day, which is classified as an Overnight Fund, to maturities ranging more than seven years as a Long Duration Fund. Liquid Fund invests in securities for a duration of up to 91 days only. Low Duration Fund invests in debt ranging from six months to twelve months. Likewise, money market, short, medium, and medium to long-duration funds invest in maturities up to one year, one to three years, three to four years, and four to seven years, respectively. Dynamic Bond Funds are diversified funds and invest in debt across durations.
These debt schemes can also be classified based on the fund management strategies or issuers of securities. Banking and PSU Funds invest a minimum of 80% in Debt instruments of banks, PSUs, Public Financial Institutions, and Municipal Bonds. The corporate bond funds only invest in AA+ and above-rated bonds, and a minimum of 80% of their investment corpus should be in AA+ and above bonds. Similarly, Credit Risk Funds invest a minimum of 65% in AA and below rated bonds. Lastly, Gilt Funds are funds that invest a minimum of 80% in G-secs across maturities.
3. Hybrid Schemes:
As the name suggests, the Hybrid funds invest in a mix of equity and debt securities. Investors who want their investments compounded coupled with a steady flow of income and capital preservation can invest in such funds.
The Hybrid Fund categories are based upon the allocation strategies. A Conservative Hybrid Fund will invest 10% to 25% in equities, with the balance being in debt. A Balanced Hybrid Fund will invest 40% to 60% in equity, with the balance being in debt. Similarly, an Aggressive Hybrid Fund will be more inclined towards equities and will invest 65%-80% in equities with the balance being in debt.
These hybrid fund categories can also invest in multiple assets (minimum of three asset classes) with a minimum allocation of at least 10% in each class. Lastly, investors do have an option to invest in arbitrage funds too. These funds are focused upon arbitrage strategies, with a minimum of 65% investment in equity and equity-related instruments.
4. Solution-Oriented & Other Funds:
These mutual funds are set up with a particular purpose. The investments are made in a manner of the fulfillment of the objective. These are generally specific financial objectives that an investor wishes to achieve and through mutual funds. The retirement funds are based upon the retirement plans of an individual. These funds have a lock-in period of at least five years or till retirement age, whichever is earlier. Similarly, there is a Children’s fund set up entirely to fund a particular future expense of the child (marriage or education).
Investors can also passively invest in Index oriented mutual funds. These funds are purely a replication of the Index, and hence the investors who want to invest passively opt for this model. Investors also can opt to invest in Fund of Funds. These are mutual funds that directly buy units of various other mutual funds, and hence their portfolio is based upon the multiple mutual funds they would invest the pooled money in.
The selection of a mutual fund category depends on the investor and his / her underlying objective. Investors need to have clearly defined objectives. Based upon the motive to invest (capital appreciation or income generation), risk appetite (high or low), and duration (short-term or long-term), one can select a particular mutual fund or combination of various mutual funds to park their money in to achieve their financial goals.