What is Mutual Fund? Definition, Types of Mutual Funds
Mutual funds have made a niche space amid a vast universe of financial products. This write-up discusses mutual fund meaning and types to help investors make an informed investment decision.
A mutual fund is an investment vehicle wherein the money put in by different investors is pooled together to create an investment portfolio. A Mutual Fund scheme invests across various types of marketable securities as per its stated investment objective While some mutual fund schemes may invest solely in a single asset class like equity or debt, others may invest in two or three asset classes.
Mutual fund schemes are managed by professional fund managers who make all the investment decisions with the help of research analysts. In return, each individual mutual fund charges certain expenses towards the investor. These include costs related to fund management, operating expenses, promotion expenses, investor awareness expenses, etc. However, the Securities & Exchange Board of India (SEBI) has prescribed certain limits on expenses that could be charged to each individual scheme. Further, investors tend to benefit from professional fund management at relatively lower costs by investing in mutual fund schemes.
Total expenses charged by the fund to the scheme are denoted by the Total Expense Ratio (TER), expressed as a percentage of total AUM (Assets Under Management). With ceiling limits of TER prescribed by SEBI (Securities & Exchange Board of India) for different scheme categories, investors can avail of professional fund management services for their investments by investing in mutual funds.
Mutual funds are also fast emerging as a preferred option for meeting an individual's financial goals according to each individual's choice of investment horizon and risk appetite. The investors can invest in different mutual fund schemes by submitting the application form physically at the Official Points of Acceptance or through the website/ mobile app of the mutual fund house, or other digital options provided by Registrar &;Transfer Agents, etc.
Here a snapshot of different asset class or categories of mutual fund schemes open for the investors to choose from:
Equity Funds– Such funds must invest at least 65% of their net assets in equity shares and equity-related instruments. Within the umbrella of equity funds, there are several sub-categories depending upon the investment objectives and type of the scheme, such as large-cap funds, mid-cap funds, small-cap funds, value funds, flexi-cap funds, dividend yield funds, etc.
Debt Funds –Such funds must invest at least 65% of their assets in debt and money market securities. There might be further restrictions on the funds' investment pattern as per their investment objective and sub-category of such schemes within the broader category of debt funds. Furthermore, sub-categories under debt funds that investors can choose based on the individual's investment horizon and risk appetite are overnight fund, liquid fund, short- duration fund, medium duration fund, gilt fund, credit risk fund, etc.
Hybrid Schemes –Such schemes offer a combination of asset classes within the investment portfolio. As such, mutual fund schemes may invest in two or more asset classes. The investment pattern is further defined by the sub-category of hybrid schemes, such as aggressive hybrid fund, conservative hybrid fund, multi-asset fund, dynamic asset allocation fund, etc.
Solution-Oriented Schemes –Such schemes are aimed at offering mutual fund schemes aimed at specific financial goals. At present, two types of solution-oriented schemes can be offered, viz. Retirement fund and Children's fund. Such schemes also carry a lock-in period of at least 5 years or till the age of retirement/ child attaining majority, whichever is earlier.
Other Schemes –Such schemes include index funds, ETFs (Exchange Traded Funds), Fund of Funds investing in domestic/ overseas securities.
Here are some of the key terms that are commonly used across for your better understanding.
Net Asset Value (NAV)
It refers to the value of one single unit of the mutual fund scheme and is calculated by dividing the valuation of the net assets of the scheme (net of liabilities) by the total units issued. SEBI requires the NAV to be published on each business day and up to four decimal places.
The NAV of a scheme becomes the basis for all the mutual fund transactions (purchase/ redemption/ switch), as units allotted in the scheme are based on the applicable NAV of the scheme. Further, the absolute investment returns are calculated by taking the NAV difference of the investment date and redemption date or any two different dates.
Total Expense Ratio (TER)
TER is calculated by dividing the total expenses charged to the mutual fund scheme with the Assets under Management (AUM). SEBI has prescribed a ceiling to the TER to be charged under different schemes. Mutual funds must disclose TER for different schemes on their website on a daily basis. Further, any change in TER is required to be communicated to the investors through various communication channels.
SEBI requires mutual funds to assign a benchmark to different schemes, making it easier for the investors to compare the performance with suitable indices. For example, a scheme may be benchmarked against S&P BSE Sensex, CRISIL Composite Bond Index, etc. Mutual funds must disclose the name(s) of benchmark index/ indices with which the scheme's performance will be compared in the scheme-related documents.
Mutual Fund investments are subject to market risk, read all scheme related documents carefully
The information herein should not be considered as 'investment advice'. Reader is requested to make informed investment decisions and consult their Mutual fund distributor or financial advisors to determine the financial implications with respect to investing in Mutual Funds