A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets. Mutual funds are operated by professional money managers, who allocate the fund's assets and attempt to produce capital gains or income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.
Mutual funds give small or individual investors access to professionally managed portfolios of equities, bonds, and other securities. Each shareholder, therefore, participates proportionally in the gains or losses of the fund. Mutual funds invest in a vast number of protection, and performance is usually tracked as the change in the total market cap of the fund—derived by the aggregating performance of the underlying investments.
Advantages of Mutual Funds for Investors
- Professional Management
Mutual funds offer investors the opportunity to earn an income or build their wealth through professional management of their investible funds. There are several aspects to such professional management viz. investing in line with the investment objective, investing based on adequate research, and ensuring that prudent investment processes are followed.
Investing in the securities markets will require the investor to open and manage multiple accounts and relationships such as broking accounts, demat accounts, and others. Mutual fund investment simplifies the process of investing and holding securities. - Affordable Portfolio Diversification
Investing in the units of a scheme provides investors the exposure to a range of securities held in the investment portfolio of the scheme in proportion to their holding in the scheme. Thus, even a tiny investment of & 500 in a mutual fund scheme can give investors proportionate ownership in a diversified investment portfolio.
As will be seen later, with diversification, an investor ensures that "all the eggs are not in the same basket". Consequently, the investor is less likely to lose money on all the investments simultaneously. Thus, diversification helps reduce the risk in investment. In order to achieve the same level of diversification as a mutual fund scheme, investors will need to set apart several lakhs of rupees. Instead, they can achieve diversification through an investment of fewer than a thousand rupees in a mutual fund scheme. - Economies of Scale
Pooling large sums of money from many investors makes it possible for the mutual fund to engage professional managers for managing investments. Individual investors with small amounts to invest cannot, by themselves, afford to engage such professional management.
Large investment corpus leads to various other economies of scale. For instance, costs related to investment research and office space get spread across investors, Further, the higher transaction volume makes it possible to negotiate better terms with brokers, bankers, and other service providers.
Mutual funds give the flexibility an investor to organize their investments according to their convenience. Direct investments may require a much higher investment amount than what many investors may be able to invest. For example, investments in gold and real estate require a large outlay. Similarly, an effectively diversified equity portfolio may require a large outlay. Mutual funds offer the same benefits at a much lower investment value since it pools small investments by multiple investors to create a large fund. Similarly, the dividend and growth options of mutual funds allow investors to structure the returns from the fund in a way that suits their requirements.
Thus, investing through a mutual fund offers a distinct economic advantage to an investor as compared to direct investing in terms of cost saving. - Liquidity
At times, investors in financial markets are stuck with security for which they can't find a buyer - worse, at times they can't find the company they invested in. Such investments, whose value the investor cannot easily realize in the market, are technically called illiquid investments and may result in losses for the investor.
Investors in a mutual fund scheme can recover the market value of their investments, from the mutual fund itself. Depending on the structure of the mutual fund scheme, this would be possible, either at any time, during specific intervals, or only on the closure of the scheme. Schemes, where the money can be recovered from the mutual fund only on the closure of the scheme, are compulsorily listed on a stock exchange. In such schemes, the investor can sell the units through the stock exchange platform to recover the prevailing value of the investment. - Tax Deferral
Mutual funds are not liable to pay tax on the income they earn. If the same income were to be earned by the investor directly, then tax may have to be paid in the same financial year.
Mutual funds offer options, whereby the investor can let the money grow in the scheme for several years. By selecting such options, it is possible for the investor to defer the tax liability. This helps investors to legally build their wealth faster than would have been the case if they were to pay taxes on their income each year. - Tax benefits
Specific schemes of mutual funds (Equity Linked Savings Schemes) give investors the benefit of deduction of the amount subscribed (up to 150,000/- in a financial year), from their income that is liable to tax. This reduces their taxable income, and therefore tax liability. - Convenient Options
The options offered under a scheme allow investors to structure their investments in line with their liquidity preference and tax position.
There are also great transaction conveniences like the ability to withdraw only part of the money from the investment account, the ability to invest an additional amount in the account, set up systematic transactions, etc. - Investment Comfort
Once an investment is made with a mutual fund, they make it convenient for the investor to make further purchases with very little documentation. This simplifies subsequent investment activity. - Regulatory Comfort
The regulator, the Securities and Exchange Board of India (SEBI), has mandated strict checks and balances in the structure of mutual funds and their activities. Mutual fund investors benefit from such protection. - Systematic Approach to Investments
Mutual funds also offer facilities that help investors invest amounts regularly through a Systematic Investment Plan (SIP); withdraw amounts regularly through a Systematic Withdrawal Plan (SWP); or move money between different kinds of schemes through a Systematic Transfer Plan (STP). Such systematic approaches promote investment discipline, which is useful in long-term wealth creation and protection. SWPs allow the investor to structure a regular cash flow from the investment account.
Types of Mutual Funds:-
- Open-ended funds
- Close-ended funds
- Interval funds
Types of Equity Schemes:-
Equity funds invest in equity instruments issued by companies. The funds target long-term appreciation in the value of the portfolio from the gains in the value of the securities held and the dividends earned on it. The securities in the portfolio are typically listed on the stock exchange, and the changes in the price of the securities are reflected in the volatile returns from the portfolio. These funds can be categorized based on the type of equity shares that are included in the portfolio and the strategy or style adopted by the fund manager to pick the securities and manage the portfolio.
1) Diversified equity funds
A diversified equity fund is a category of funds that invest in a diverse mix of securities that cut across sectors and market capitalization. The risk of the fund performance being significantly affected by the poor performance of one sector or segment is low.
2) Market Segment based funds
Market Segment based funds invest in companies of particular market size. Equity stocks may be segmented based on market capitalization as large-cap, mid-cap, and small-cap stocks.
- Large-cap funds invest in stocks of large, liquid blue-chip companies with stable performance and returns.
- Mid-cap funds invest in mid-cap companies that have the potential for faster growth and higher returns. These companies are more susceptible to economic downturns. Therefore, evaluating and selecting the right companies becomes important. Funds that invest in such companies have a higher risk, since the selected companies may not be able to withstand the slowdown in revenues and profits. Similarly, the price of the stocks also falls more when markets fall.
- Small-cap funds invest in companies with small market capitalization with the intent of benefitting from the higher gains in the price of stocks. The risks are also higher.
Definition of Large-Cap, Mid-Cap, and Small-Cap:-
In order to ensure uniformity in respect of the investment universe for equity schemes, it has been decided by SEBI to define large-cap, mid-cap, and small-cap as follows:
- Large-Cap: 1st-100th company in terms of full market capitalization
- Mid-Cap: 101st-250th company in terms of full market capitalization
- Small-Cap: 251st company onwards in terms of full market capitalization
Mutual Funds would be required to adopt the list of stocks prepared by AMFI in this regard and AMFI would adhere to the following points while preparing the list:
- If a stock is listed on more than one recognized stock exchange, an average of the full market capitalization of the stock on all such stock exchanges, will be computed.
- In case a stock is listed on only one of the recognized stock exchanges, the full market capitalization of that stock on such an exchange will be considered.
- This list would be uploaded on the AMFI website and the same would be updated every six months based on the data as of the end of June and December of each year. The data shall be available on the AMFI website within 5 calendar days from the end of the 6 months period.
3) Sector funds
Sector funds invest in only a specific sector. For example, a banking sector fund will invest in only shares of banking companies. Gold sector funds will invest in only shares of gold-related companies. The performance of such funds can see periods of under-performance and out-performance as it is linked to the performance of the sector, which tends to be cyclical. Entry and exit into these funds need to be timed well so that the investor does not invest when the sector has peaked and exit when the sector performance falls. This makes the scheme riskier than a diversified equity scheme.
4) Thematic funds
Thematic funds invest in line with an investment theme. For example, an infrastructure thematic fund might invest in shares of companies that are into infrastructure construction, infrastructure toll collection, cement, steel, telecom, power, etc.
The investment is thus more broad-based than a sector fund, but narrower than a diversified equity fund and still has the risk of concentration.
5) Strategy-based Schemes
Strategy-based Schemes have portfolios that are created and managed according to a stated style or strategy.
6) Equity Income/ Dividend Yield Schemes
Equity Income/ Dividend Yield Schemes invest in securities whose shares fluctuate less, and the dividend represents a larger proportion of the returns on those shares. They represent companies with stable earnings but not many opportunities for growth or expansion. The NAV of such equity schemes is expected to fluctuate lesser than other categories of equity schemes.
7) Value fund
Value fund invests in shares of fundamentally strong companies that are currently undervalued in the market with the expectation of benefitting from an increase in price as the market recognizes the true value. Such funds have a lower risk. They require a longer investment horizon for the strategy to play out.
8) Growth funds
Growth funds portfolios feature companies whose earnings are expected to grow at a rate higher than the average rate. These funds aim at providing capital appreciation to investors and provide above-average returns in bullish markets. The volatility in returns is higher in such funds.
9) Focused funds
Focused funds hold portfolios concentrated in a limited number of stocks. Selection risks are high in such funds. If the fund manager selects the right stocks then the strategy pays off. If even a few of the stocks do not perform as expected the impact on the scheme returns can be significant as they constitute a large part of the portfolio.
10) Equity Linked Savings Schemes (ELSS)
Equity Linked Savings Schemes (ELSS) are diversified equity funds that offer tax benefits to investors under section 80C of the Income Tax Act up to an investment limit of 7 1,50,000 a year. ELSS is required to hold at least 80 percent of its portfolio in equity instruments. The investment is subject to lock-in for a period of 3 years during which it cannot be redeemed, transferred, or pledged. However, this is subject to change in case there are any amendments in the ELSS Guidelines with respect to the lock-in period.
SEBI has introduced the categorization of open-end mutual funds to ensure uniformity in the characteristics of similar types of schemes launched by different mutual funds.
This will help investors to evaluate the different options available before making an informed decision to invest.!
As per the SEBI circular, open-end equity mutual fund schemes have been categorized under the following sub-heads:
11) Multi Cap Fund
Multi Cap Fund is an open-ended equity scheme investing across large-cap, mid-cap, and small-cap stocks. The minimum investment in equity and equity-related instruments shall be 65 percent of total assets.
12) Large Cap Fund
Large Cap Fund is an open-ended equity scheme predominantly investing in large-cap stocks. The minimum investment in equity and equity-related instruments of large-cap companies shall be 80 percent of total assets.
13) Large and Mid-Cap Fund
Large and Mid-Cap Fund is an open-ended equity scheme investing in both large-cap and mid-cap stocks. The minimum investment in equity and equity-related instruments of large-cap companies shall be 35 percent of total assets. The minimum investment in equity and equity-related instruments of mid-cap stocks shall be 35 percent of total assets.
14) Mid-Cap Fund
Mid Cap Fund is an open-ended equity scheme predominantly investing in mid-cap stocks. The minimum investment in equity and equity-related instruments of mid-cap companies shall be 65 percent of total assets.
15) Small cap Fund
Small-cap Fund is an open-ended equity scheme predominantly investing in small-cap stocks. The minimum investment in equity and equity-related instruments of small-cap companies shall be 65 percent of total assets.
16) Dividend Yield Fund
Dividend Yield Fund is an open-ended equity scheme predominantly investing in dividend-yielding stocks. The scheme should predominantly invest in dividend-yielding stocks. The minimum investment in equity shall be 65 percent of total assets.
17) Value Fund or Contra Fund
Value Fund or Contra Fund A value fund is an open-ended equity scheme following a value investment strategy. Minimum investment in equity 82 equity-related instruments shall be 65 percent of total assets. A contra fund is an open-ended equity scheme following a contrarian investment strategy. Mutual Funds will be permitted to offer either Value fund or Contra fund.
18) Focused Fund
A focused Fund is an open-ended equity scheme investing in a maximum of 30 stocks (the scheme needs to mention where it intends to focus, viz., multi-cap, large-cap, mid-cap, small-cap). Minimum investment in equity & equity-related instruments shall be 65 percent of total assets.
19) Sectoral/Thematic
Sectoral /Thematic is an open-ended equity scheme investing in a specific sector such as a bank, power is a sectoral fund. While an open-ended equity scheme invests in line with an investment theme. For example, an infrastructure thematic fund might invest in shares of companies that are into infrastructure, construction, cement, steel, telecom, power, etc. The minimum investment in equity & equity-related instruments of a particular sector/ particular theme shall be 80 percent of total assets.
