Mutual funds are a secure investment, seen as a good way for investors to diversify with minimal risk. But there are circumstances where a mutual fund is not a good choice for a market participant, especially regarding fees. On the other hand, mutual funds offer one of the most comprehensive, easy, and flexible ways to create a diversified portfolio of investments. Moreover, mutual funds provide various options to suit investors' diverse risk hunger. Let us understand the different types of mutual funds available currently in the market to help you make an informed investment decision.
Overview-Types of Mutual Funds
There are a combination of schemes offered by mutual funds in India, which cater to different categories of investors to suit different financial objectives, e.g., some schemes may provide capital protection for the risk-averse investor. In contrast, some other schemes may provide capital appreciation by investing in the mid or small-cap part of the equity market for the more aggressive investor. Mutual Fund schemes can be classified into different categories and subcategories based on their investment objectives or maturity periods.
Types of Mutual Funds
A mutual fund can be categorized based on various characteristics. Below mentioned are the types of Mutual Funds-
Based on Investment Goals
Growth funds are mutual funds that aim at achieving capital appreciation through investing funds in growth stocks. Growth funds focus their attention on companies and organizations displaying exceptional revenue or earnings growth instead of companies that pay out dividends.
Income Funds are categorized under the debt mutual funds category and function as a steady source of income for investors. The diversification of funds helps investors by enabling them to invest in equities as well as bonds. Further, it allows investing in numerous asset classes like Certificates of Deposits (CD), money market instruments, government securities, and corporate bonds, prioritizing assets with higher interest rates. The high dividends generated can either be invested or distributed among the investors.
Liquid funds are the funds that invest in fixed-income securities such as certificates of deposit, treasury bills, commercial papers, and other debt securities that mature within 91 days. Liquid funds do not come with a lock-in period. The redemption requests of liquid funds are processed within 24 hours on business days.
The risk levels of liquid funds are on the lower side. Liquid funds are considered the least risky among all debt funds as they primarily invest in high-quality fixed-income securities that mature soon. Therefore, these funds are suitable for risk-averse investors.
Tax Savings Funds
Tax-saving mutual funds are those funds where investors invest at least 80% of their assets in equities. The tax-saving mutual funds are essentially equity-linked saving schemes (ELSS) that offer tax advantages to the investors under Section 80C of the Income Tax Act, 1961. The lock-in period inculcates a good habit among investors to thrive for long-term investing while putting their money in an equity-related instrument. These tax-saving mutual funds also maximize portfolio returns over the long term to an investor. However, investors should also be wary of the risk associated with equity investing as compared to the other tax-saving fixed-income instruments like Public Provident Fund (PPF) & others.
Aggressive Growth Funds
Aggressive hybrid funds are open-angled mutual funds that invest in both equity and debt securities. These funds are right for investors who want a taste of market volatility but with moderate risk tolerance.
Capital Protection Funds
A capital protection fund is a closed-end hybrid fund. This fund's preliminary goal is safeguarding an investor's capital during market downturns. Simultaneously, it offers them scope for capital appreciation by participating in upturns of the stock market.
This fund invests in a combination of fixed income instruments such as bonds, certificate of deposits (CDs), treasury bills, and equity instruments. In other words, most of the fund amount is invested in fixed income securities to earn stable returns on the invested capital. Besides this, a small portion of the portfolio has investments towards equity to take advantage of the growth advantages and provide capital appreciation.
Fixed Maturity Funds
Fixed maturity plans are a class of debt funds that mainly invest in fixed income instruments such as a certificate of deposit or bonds that lock in the currently available yields. This is done to eliminate interest rate fluctuation faced by debt markets.
Fixed maturity plans are close-ended mutual fund schemes with a pre-defined maturity. The tenure varies from 30 days to 5 years. The most commonly available tenures range from 30 days to 180 days, 370 days, and 395 days.
A pension fund, which is also known as a superannuation fund, is a scheme that facilitates retirement income. These funds are combined monetary contributions from pension plans set up by employers, unions, or other entities to provide for their employees' or members' retirement benefits. Pension funds are the most significant investment blocks in most countries and dominate the stock markets where they invest. When managed by professional fund managers, they constitute the institutional investor sector, insurance companies, and investment trusts. Typically, pension funds are exempt from the capital gains tax, and the earnings on their investment portfolios are either tax-deferred or tax-exempt.
Based on Asset Class
Equity mutual funds are the funds that aim to get returns by investing in stocks of publicly listed companies across market capitalizations. Equity mutual funds typically come with moderate to high risk. The performance of the companies the mutual fund invests in plays a crucial role in deciding the investors' returns. Investors may invest in equity funds depending on their risk profile, investment horizon, and goals. Equity mutual funds are generally suited for the long term, five years or more.
A debt mutual fund (also known as a fixed-income fund) where an investor invests a considerable portion of the money in fixed-income securities like government securities, debentures, corporate bonds, and other money-market instruments. By investing money in such avenues, debt mutual funds lower the risk factor considerably for investors. This is a relatively stable investment avenue that could help to generate wealth.
Money Market Funds
Money Market Funds are debt funds that loan to companies for up to 1 year. These Funds are designed to allow the fund manager to generate higher returns while keeping risk under control through adjustment of lending duration. Higher loan tenure usually comes with higher returns.
Hybrid funds are mutual funds that are represented by diversification within two or more asset classes, e.g., equity, fixed income, gold, etc. Hybrid funds, also known as asset allocation funds, offer investors exposure to multiple asset classes and risk diversification through a single investment. Several types of hybrid funds have varying risk levels ranging from conservative, high risk to very high-risk profiles.
Based on Structure
Open Ended Funds
Open-ended funds are continuously open to investment and redemptions; hence, the name open-ended funds. Open-ended funds are a considerably common form of investment in mutual funds in India. These funds do not have any lock-in period or maturities; therefore, it is open perennially. Generally, open-ended funds do not have any maximum limit (of AUM) up to which it can collect investments from the public. In open-ended funds, the NAV is calculated daily on the value of the underlying securities at the end of the day. These funds are usually not traded on stock exchanges. The big difference between open-ended and closed-ended mutual funds is that open-ended funds always offer high liquidity compared to close-ended funds, where liquidity is available only after the specified lock-in period or at the fund maturity.
Close Ended Funds
A closed-ended Funds are mutual funds where your investment is locked in for a specified period. You can subscribe to close-ended schemes only during the new fund offer period (NFO) and redeem the units only after the lock-in period or the scheme's tenure is over. However, some closed-ended funds become open-ended after the lock-in period. Sometimes, AMCs might transfer the proceeds of closed-ended funds post the maturity period to another open-ended fund. But to do this, consent of the investors of the said closed-ended fund is needed. While comparing open-ended and closed-ended funds, some investment experts argue that the lock-in period ensures that the fund's assets remain stable due to the specified lock-in. In addition, it gives the fund manager flexibility to create a portfolio with long-term growth prospects without fearing outflows through deliverance like in an open-ended fund.
Interval Funds are a kind of mutual fund scheme in which the units can be purchased and sold only at predetermined time intervals. For example, the fund house specifies every fifteen days or any other time period. Although Interval Funds can invest in debt and equities, it usually invests in debt securities. Like any other mutual fund, Interval Funds are taxed according to how much is invested in debt or equities.
Based on Risk
Low risk Mutual Funds: Low-risk mutual funds are the mutual funds where the investments made are by those who do not want to take a risk with their money. In such cases, investments are made in places like the debt market and tend to be long-term investments. As a result of low risk, the returns on these investments are also low. One example of a low-risk fund would be gilt funds, where investments are made in government securities.
Medium risk Mutual Funds: These investments come with a medium-level risk to the investor. They are ideal for those who are willing to take some risk with the investment and tend to offer higher returns. These funds can be used as an investment to build wealth over a more extended period.
High risk Mutual Funds: These are mutual funds ideal for those willing to take higher risks with their money and looking to build their wealth. One example of high-risk funds would be inverse mutual funds. Even though these funds have high risks, they also offer higher returns.
Sector Funds: These are funds that invest in a particular sector of the market, e.g., Infrastructure funds invest only in those instruments or companies that relate to the infrastructure sector. Returns are tied to the performance of the chosen sector. The risk involved in these schemes depends on the nature of the sector.
Index Funds: These are funds that invest in instruments that represent a particular index on an exchange so as to mirror the movement and returns of the index, e.g., buying shares representative of the BSE Sensex.
Fund of funds: These are funds that invest in other mutual funds, and returns depend on the performance of the target fund. These funds can also be referred to as multi-manager funds. These investments can be considered relatively safe because the fund's investors actually hold other funds under them, thereby adjusting for risk from any one fund.
Emerging market funds: These are funds where investments are made in developing countries that show good prospects for the future. They come with higher risks due to the dynamic political and economic situations prevailing in the country.
International funds: These are also known as foreign funds and offer investments in companies located in other parts of the world. These companies could also be located in emerging economies. The only companies that won't be invested in will be those located in the investor's own country.
Global funds: These are funds where the investment made by the fund can be in a company in any part of the world. They are different from international/foreign funds because, in global funds, investments can be made even in the investor's own country.
Real estate funds: These are the funds that invest in companies that operate in the real estate sector. These funds can be invested in realtors, builders, property management companies, and companies providing loans. The investment in real estate can be made at any stage, including projects in the planning phase, partially completed, and completed.
Commodity-focused stock funds: These funds don't invest directly in the commodities. They invest in companies working in the commodities market, such as mining companies or producers of commodities. These funds can, at times, perform the same way the commodity is due to their association with their production.
Market neutral funds: These funds are called market neutral because they don't invest in the markets directly. They invest in treasury bills, ETFs, and securities and try to target fixed and steady growth.
Inverse/leveraged funds: These are funds that operate, unlike traditional mutual funds. The earnings from these funds happen when the markets fall, and when markets do well, these funds tend to go into loss. These are generally meant only for those who are willing to incur massive losses but at the same time can provide huge returns as well, as a result of the higher risk they carry.
Asset allocation funds: The asset allocation fund comes in two variants, the target date fund, and the target allocation funds. The portfolio managers can adjust the allocated assets in these funds to achieve results. These funds split the invested amounts and invest them in various instruments like bonds and equity.
Gilt Funds: In Gilt Funds, the funds are invested in government securities for the long term. Since they are invested in government securities, they are virtually risk-free and can be the ideal investment for those who don't want to take risks.
Exchange-traded funds: These are funds that are a mix of both open and close-ended mutual funds and are traded on the stock markets. These funds are not actively managed; they are managed passively and can offer a lot of liquidity. As a result of their being managed passively, they tend to have lower service charges (entry/exit load) associated with them.
Conclusively, we can say that Mutual funds are created as baskets of investments, which invest in financial instruments like stocks and bonds as per their defined investment objectives. Mutual funds provide diversification through exposure to a large number of stocks. Various types of mutual funds help in avoiding various issues and helps in generating long term wealth.