Different Types of Mutual Fund schemes and Its Benefits

Published On: 11-Sep-2020

Mutual funds have been emerging as a preferred investment option amongst retail investors because of the convenience of investing and professional fund management. Investors may choose from different types of mutual funds in India that are broadly classified into five major categories. 

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Here are the various types of mutual funds one may invest in:

1. Equity Schemes 

Equity mutual funds invest predominantly in equities and equity-related securities. These funds provide an excellent alternative to investing in stocks directly and the benefit of professional fund management. Considering the broad investment objective of different categories of equity funds, they may be further classified as follows:

  1. Based on Market Capitalisation 

Mutual funds focus on investing in companies in a specific market capitalisation segment. Examples of such funds are multi-cap fund, large-cap fund, mid-cap fund, small-cap fund, etc. SEBI defines market capitalisation segments based on the ranking of companies as per the full market capitalisation on a half-yearly basis. 

The top 100 companies in such a list are categorised as large-cap companies; the companies featuring between rank 101 and 250 are categorised as mid-cap companies. The companies ranked beyond 250th rank are classified as small-cap companies. With their respective market capitalization segment, different companies generally reflect varied fundamental strength and growth potential. Different equity funds based on such classification tend to reflect a similar risk profile.

  1. Based on investing strategy – Equity funds may also be categorised based on the investing strategies adopted by such funds. Examples of such funds are contra fund, value fund, focused fund, dividend yield fund, sectoral/ thematic fund, etc. Investors may invest in such funds to balance the portfolio risk.

  2. Tax-saving Funds – Equity Linked Savings Schemes (ELSS) are a specified category of mutual fund schemes that are eligible for tax deduction up to Rs. 1.50 lakh under Section 80C of the Income Tax Act 1961 and carry a lock-in period of 3 years from allotment date.

2. Debt Funds

Debt funds invest predominantly in debt securities. Such funds tend to generate returns for the investors primarily through the accrual of interest income. Some of the funds may also generate better returns through appreciation in portfolio valuation due to favourable changes in interest rates and improvement in credit quality. Here are the different types of debt funds available for the investors:

  1. Overnight and Liquid Funds – Such funds invest in short-term securities with one-day maturity and up to 91 days maturity, respectively. With a lower maturity period, such funds carry insignificant interest rate risk and credit risk. These funds are suited to invest short-term surplus funds and emergency fund corpus.

  2. Duration funds – Such funds aim to invest in debt securities with different durations. The examples of duration funds are ultra-short duration fund, short duration fund, medium duration fund, etc. The interest rate risk is directly proportional to the fund duration, and thus, the investors may choose the specific duration fund based on their risk appetite. 

  3. Gilt funds – As the name suggests, such funds predominantly invest in Government Securities (G-Secs) across different maturities. As the portfolio comprises mainly sovereign securities, such funds carry insignificant credit risk but may be subject to interest rate risk based on the portfolio duration. 

  4. Credit Opportunities Funds – Such funds aim to capitalize on the opportunities available across the credit spectrum. The difference in the yields of a risk-free Government Security and a debt security with a specific credit rating is referred to as the credit spread. 

As such, lower the credit rating, higher would be the credit spread and, consequently, the yield. Credit Opportunities funds, thus, aim to generate better returns by creating an investment portfolio of debt instruments with varied credit ratings. Examples of such funds are banking & PSU funds, corporate bond funds, etc. 

3. Hybrid Funds

Such funds create a combination of equity and debt investments within its investment portfolio. As such, hybrid funds allow investors to invest in different asset classes with a single investment product. Such funds may vary from conservative hybrid funds to aggressive hybrid funds or may be dynamic asset allocation funds. Further, SEBI also allows mutual funds to offer multi-asset funds, enabling investment exposure to three or more asset classes. 

4. Solution-Oriented Schemes

Mutual funds may also allow solution-oriented schemes catering to specific financial goals, such as child’s education, retirement planning, etc. Such schemes have a lock-in period of 5 years or reaching the child’s majority or retirement age, whichever is earlier. As such, the investors are benefited with an implied resistance liquidate their investments sooner. 

5. Other Schemes

This is the residual category for the mutual funds, comprising of index funds/ ETFs (Exchange Traded Funds), Fund of Funds (domestic/ overseas). While index funds/ ETFs mirror an underlying index, and are passive investment products, Fund of Funds (FoFs) create an investment portfolio comprising of other mutual fund schemes, instead of directly investing in different securities. Therefore, investors may benefit from the investment experience of its fund manager managing FoF and the fund manager managing the schemes in which such FoF has invested.

With different mutual funds offering various benefits and carrying different investment risks, the investors should make an informed decision about their investments.