Types of Mutual funds
When it comes to choosing one mutual fund to invest in from so many different types, styles and fancy named mutual funds available to choose from, we think keep it simple strategy helps. Otherwise the process becomes quite overwhelming and chances of it being counterproductive increases. We have summarized the bullet points of the mutual funds which Wealthcon considers worth understanding and considering in decision making process here.
Bullet points of asset class based mutual funds categories:
- Equity funds:
Equity funds are the funds that invest in equities i.e. shares of the companies.
These funds invest 75-90% or more of its assets in equity and keep small portion in cash or debt funds.
These are further categorized as Large cap (LC) , Mid cap (MC) , Small cap (SC) , Multi cap (MC) funds, Sectoral funds, Thematic funds, Arbitrage funds, Index funds, Exchange traded funds (ETF),Tax saving funds/ ELSS. Also some fancy funds like contra funds, value funds, children’s funds, pension funds which are named based on their investment style or objective of investment are available.
These are suitable for long term investment, with investment horizon of more than 7 years.
One should invest in these funds with the objective of capital appreciation or wealth creation.
Expected return from these funds should be 12- 15 % CAGR over a long term period.
Risk of investing in these funds is medium to high. Volatility is high. hey are subject to market volatility risk, economy risk, company/ business risk and global economy risk.
Taxation: STCG tax; 15% if held for less than one year.
LTCG tax; gains over and above 1 Lac per annum are taxable at 10% if held for more than 1 year.
*Note- While there are variety of equity mutual funds available to choose from, ultimately they all invest in combination of Large cap, Mid cap or Small cap companies to achieve their objectives. So logically keeping things simple and investing directly in just large cap, mid cap and small cap funds makes sense.
Other equity funds we believe are worth focusing on are ELSS, Arbitrage funds, Index Funds and Exchange traded funds. We will talk about them later.
- Debt funds:
Debt funds invest in fixed-income securities like bonds, government securities, treasury bills, commercial papers and debentures, Money market instruments, Bank certificate of deposits etc.
These funds are further categorized as Long duration, medium duration, medium to long duration, short duration, Low duration, ultra short duration, Liquid funds, money market, overnight, dynamic bond, corporate bond, credit risk, Gilt funds.
These are suitable for short to medium term investment, with investment horizon of few days, months to less than 3 years.
One should invest in these funds with the objective of capital protection with small regular income.
Expected returns from these funds should be 6-8% CAGR.
These are relatively low risk with low volatility. They are subject to interest rate risk and credit risk.
STCG Tax -If held for less than 3 years, capital gain is added to personal income and taxed as per the personal tax slab.
LTCG tax – if held for 3 years or more, capital gain is taxed at 20% after indexation or10%flat without indexation.
- Hybrid funds:
These funds invest in equity and debt, in 50 to 70% proportion. When 65% or more of the fund’s assets are invested in equity and rest in debt and money market instruments, it is called an equity oriented fund. When 65% or more of the fund’s assets are invested in debt and rest in equity, it is called a debt oriented fund.
These are categorized as aggressive hybrids, conservative hybrids, balance hybrids, Dynamic asset allocation, Multi asset allocation. Balnaced funds ( equity oriented) and Balanced funds (Debt oriented).
Objective is periodic return with capital appreciation.
Expected returns should be 8-10% CAGR.
These are suitable for conservative investors with Investment horizon of 3 to 7 years. These could be suitable for achieving medium term goals and also retirees looking for regular income.
They are medium to high risk instruments, exposed to same risks as equity and debt funds. However they are less volatile than pure equity funds as the debt products in portfolio brings some stability to funds in times of uncertain market conditions.
Tax: Debt portion of hybrid funds is taxed liked debt fund and equity portion is taxed as equity fund.
4) Gold funds:
These funds invest in physical gold or units of Gold Exchange Traded Funds (ETF).
These are suitable for investors looking for diversification of portfolio / asset allocation.
These funds perform well in times of uncertainty, market crisis, political and economical uncertainty.
Not a suitable investment for long term or for wealth creation.
Average returns are 3-4% CAGR in longer term Performs well during market crisis, other times are laggards.
Tax: Taxation is similar to debt funds.
Bullet points of relevant mutual funds from above main categories.
These are debt category of mutual funds.
They invest in very short-term market instruments like treasury bills, government securities and Call money, instruments with maturity period not more than 91 days.
These are suitable for investors who wish to park their idle money for a short period of time, with aim to preserve capital.
These mutual funds have no lock in period, and are highly liquid. These can be redeemed as and when required and proceeds are credited to your account within 1-2 days.
They are lowest risk and least volatile among all types of debt mutual funds.
Returns are 7-8% over long term periods, which are higher than interest rate offered on savings account.
Tax: Taxed as debt funds.
These are a type of equity funds. They exploit the price differential between the cash and futures markets. The fund manager buys shares in the cash and sells it in futures market simultaneously. The difference in the price is the return fund earns. These are low risk, and expected returns are approximately 7-8% CAGR.
These are suitable for short to medium term investors having a time horizon of 3 to 5 years. Exit load may apply for exit before 1 year, advisable to check the exit policy. Also suitable for investors who wish to park their excess funds for short term.
These funds tend to perform well in high volatility.
Taxation: treated as equity funds for the taxation purpose.
These funds are equity funds, that invest in a market index- like Nifty, Nifty next 50, Nifty 500 and so on.
Their performance is identical to the index they are tracking.
They are low risk and low expense ratio funds compared to actively managed equity funds and are suitable for risk-averse investors looking for returns close to that of index returns. Theoretically good actively managed funds tend to beat index returns.
They are subject to tracking error, choose a fund with less tracking error.
These are suitable for long term investment, more than 7 years.
Expected returns are in the range of 10% to 20%.
Taxation: Taxed as equity funds.
Exchange traded funds:
These are Index funds listed and traded on stock exchanges like shares.
Liquidbees are exchange traded liquid funds; Liquid fund ETF.
Nifty bees are exchange traded nifty funds; Nifty 50 ETF.
Goldbees are exchange traded gold funds; Gold ETF.
Equity linked savings scheme (ELSS):
These are close ended, equity mutual funds with lock in period of 3 years.
They offer tax benefits under section 80C of the income tax act 1961.
Tax: Investment up to 1.5 Lac per year are tax exempt. However capital gains are trated as LTCG and gains over 1 lac per annum are taxed at 10%.
Large cap funds:
These funds invests minimum 805 of their total assets in companies with large market capitalization.
Large cap companies are the companies among the top 100 companies in terms of market capitalization. These companies are known for stability and steady growth with better corporate governance.
The volatility and risk in these funds is low compared to mid cap and small cap funds, and these could be suitable for relatively risk averse investors, looking for moderate steady return over long term.
Taxation: same as equity funds.
Mid cap funds:
These equity mutual funds invest minimum 65% of their total assets in shares of mid-sized companies.
Mid-sized companies are the companies amongst the 101th to 250 th company in terms of market capitalization.
These are very volatile and high risk funds and can erode wealth in bear phase; at the same time they have ability to outperform large-cap funds and index particularly in bull market.
Small cap funds:
As the name suggests these equity mutual funds invests minimum 65% of their total assets in small-cap companies.
Small cap companies are all the companies from 251st companies onwards in terms of full market capitalization.
These funds are highly volatile and most risky amongst all equity funds, in the bear phase of market they have potential to correct significantly and in bull phase they tend to outperform.
They can be around 20% of your total equity portfolio depending on your age, risk profile and financial goals. Invest in these funds with more than 7 year time horizon only.
You can read more about categorization and rationalization of various mutual fund categories in recent SEBI circular; see the link below:
|Type||Equity Find||Debt Fund||Hybrid Fund||Gold Fund|
|Asset composition||Minimum 65% Equities||Minimum 36% in Debt and Debt instruments||Debt + Equity 50 to 70% proportion||98- 100% in physical gold, Gold ETF|
|Investment objective||Long term capital appreciation||Capital preservation and small periodic returns||Periodic returns and Capital appreciation||Portfolio diversification|
|Time Horizon||More than 7 years||From few days to less than 3 years||From 3 to 7 years||Should be 5-10% of portfolio, long term|
|Long term returns expectations||12% to15%||6% to 9%||8%to 10%||3%-4%|
|Risk||High volatility, high risk. Subject to Market risk, Economy risk, Company risk, Global economy risk.||Low volatility, low to medium risk. Subject to Interest rate risk and Credit risk. Liquid funds are relatively risk free.||Low volatility, Medium to moderate risk. Subject to same risks as equity and debt funds risk, However debt component performs well when equity is not performing well and vice versa. Both asset classes balance out each other.||Low risk. Performs well in times of political and economy uncertainty.|
|Taxation||LTCG: Taxable at 10% when held for more than 1 year. STCG: anything above 1 Lac per annum; 15% when held for less than 1 year.||LTCG: Taxable at 20% with indexation or 10% without indexation, if held for more than 3 years. STCG: Added to personal income and taxable as per personal tax slab.||Equity component taxable as equity fund and debt component taxable as debt funds.||Taxable as debt fund.|