Investing in mutual funds is not a simple decision that you can make overnight. It involves a great deal of research and careful planning, primarily because there are so many different types of mutual funds available in the Indian financial market. To find the right scheme for your portfolio, you’ll need to first understand what the different mutual fund schemes are all about. 

So, let’s dive right into the topic we’ll be covering in this chapter - the types of mutual funds in India. To be more specific, we’ll be looking at the types of mutual funds based on the kind of assets they invest in. 

Equity mutual funds

Equity mutual fund schemes invest predominantly in the equity shares of different companies. The stocks chosen may belong to companies in different sectors, companies with different market caps, or even simply be different based on their growth rate or investment horizon. Since these funds invest in the direct equity segment, they carry a higher level or risk than most other kinds of mutual funds. That said, they are also generally known to deliver higher returns, particularly over the long term. 

Types of equity mutual funds

Equity mutual funds can further be classified into different types of mutual fund schemes, based on the market capitalization of the companies whose stocks they invest in. Here are the main kinds of equity funds based on market cap.

• Large-cap funds

Large-cap funds invest in the equity stocks of large-cap companies, which are the top 100 companies in terms of market capitalization. They are generally more stable than other equity funds, mainly because large-cap companies are considered to be financially strong. 

• Mid-cap funds

Mid-cap funds, as the name indicates, invest in the equity stocks of mid-cap companies. These are the companies ranked from 101 to 250 in terms of market cap. These funds may be more volatile than large-cap funds.

• Small-cap funds

Small-cap funds invest in small-cap companies. These are ranked at the 251st place and lower, in terms of market cap. A major portion of all the companies listed on the Indian stock exchanges fall under this category. They may have the potential to offer higher returns, but they are typically highly volatile. 

• Multi-cap funds

Multi-cap funds invest in a mix of equity stocks from large-cap, mid-cap and small-cap funds. The proportion of distributing the capital across these categories may vary, and it is often rebalanced by fund managers according to new economic developments and changing market conditions. 

Debt mutual funds

Debt funds are mutual fund schemes that invest primarily in debt securities. Generally, these assets generate fixed income periodically. Alternatively, in some cases, they may offer guaranteed returns after a specified period. Whatever the case may be, the rate of return is typically known upfront, making debt mutual funds one of the safest mutual fund investment options you can consider for your portfolio. 

What do debt mutual funds invest in?

Debt mutual funds invest in high quality debt instruments. These securities generally offer lower rates of return than equity stocks. However, they are also less risky. Some debt mutual funds may invest in debt securities that carry a lower credit rating, meaning that the risk of default may be slightly higher. However, to compensate, the returns expected are also on the higher side. Here is a closer look at the kinds of securities that debt funds invest in.

• Government bonds

These are debt instruments that are issued by the government of India. They are long-term securities that offer interest either at a fixed rate, or at a floating rate of interest. So, based on the interest rates, there are types of government bonds namely fixed rate bonds and floating rate bonds. Since these bonds are backed by the government and come with the sovereign guarantee, they are considered to be one of the safest investments available in the market. 

• Corporate bonds

Corporate bonds are just like government bonds. However, they are issued by corporate entities instead of the government. So, the degree of risk carried by corporate bonds is higher. However, they also often offer interest at higher rates than government securities. 

• Money market instruments

Money market instruments are short-term financial assets that are traded in the markets. Mutual funds may also invest in these securities, based on the objectives of the scheme. Some common money market instruments include treasury bills, certificates of deposit (CDs) and commercial papers (CPs). The defining characteristics of money market instruments include liquidity, safety and an issue price that is discounted from their face value.

Hybrid funds

Hybrid mutual fund schemes invest in a combination of debt and equity instruments in varying proportions. They do not always offer additional weightage to either of these asset classes. Based on market conditions and the rates of return on fixed income assets, the proportion of investments in equity and debt will continue to vary. 

Hybrid funds help you create a balanced investment portfolio that is diversified at some level, since it includes two kinds of asset classes already. So, if you are unsure of what type of mutual fund to begin investing in, hybrid funds may give you a good head start. 

Gold funds

Gold funds, as the name makes it evident, invest in the yellow metal. Some gold funds invest directly in gold bullion in the form of gold bars and coins, while others may invest in stocks of companies involved in the business of mining gold or manufacturing gold products. These funds give you an opportunity to invest in the yellow metal without the hassle of owning it physically. It also allows you to benefit from the expertise of a fund manager. 

Wrapping up

This merely sums up the types of mutual funds based on the asset classes they invest in. But aside from this, are all mutual funds similar in all other respects? Well, as it turns out, they are not similar at all. In fact, there are different types of mutual funds based on their structure, investment horizon and other factors. Head to the next chapter for all the details.

A quick recap

• Equity mutual fund schemes invest predominantly in the equity shares of different companies. 
• Equity mutual funds can further be classified into different types of mutual fund schemes, based on the market capitalization of the companies whose stocks they invest in. They can be large-cap, mid-cap, small-cap or multi-cap funds.
• Debt funds are mutual fund schemes that invest primarily in debt securities. Generally, these assets generate fixed income periodically. Alternatively, in some cases, they may offer guaranteed returns after a specified period. 
• Hybrid mutual fund schemes invest in a combination of debt and equity instruments in varying proportions. 
• Gold funds, as the name makes it evident, invest in the yellow metal. Some gold funds invest directly in gold bullion in the form of gold bars and coins, while others may invest in stocks of companies involved in the business of mining gold or manufacturing gold products.