What is Mutual Fund? Definition, Types of Mutual Funds

Published On: 06-Jul-2021

A mutual fund is an investment vehicle wherein the money invested by different investors is pooled together to create an investment portfolio. A Mutual Fund scheme invests across various type of marketable securities as per the stated investment objective of each individual schemes.

The investment decisions are made by professional fund managers, backed by a team of research analysts. In return, each individual scheme charges certain expenses to the investor of the scheme towards costs related to fund management, operating expenses, distribution expenses, investor awareness, etc. However, Securities & Exchange Board of India (SEBI) has prescribed certain limits on expenses that could be charged to each individual schemes. Further, the investors tend to benefit from professional fund management at relatively lower costs by investing in mutual fund schemes

Mutual funds are also fast emerging as a preferred option for meeting 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:

  1. 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. 
  2. 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 where 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. 
  3. 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. 
  4. 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. 
  5. 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. 

NAV of the scheme becomes the basis for all the mutual fund transactions (purchase/ redemption/ switch), as units allotted in the scheme is based on the applicable NAV of the scheme. Further, the absolute investment returns are calculated by taking the NAV difference of 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 daily basis. Further, any change in TER is required to be communicated to the investors through different communication channels.

Benchmark

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. 

Disclaimers:

Mutual Fund investments are subject to market risk, read all scheme related documents carefully

This material is part of Investor Education and awareness initiative of UTI Mutual Fund.

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