Mutual funds in India are broadly classified into equity funds, debt funds, and balanced mutual funds, depending on their asset allocation and equity exposure. Therefore, the risk assumed and returns provided by a mutual fund plan would depend on its type. We have broken down the types of mutual funds in detail below:
Equity funds, as the name suggests, invest mostly in equity shares of companies across all market capitalisations. A mutual fund is categorised under equity fund if it invests at least 65% of its portfolio in equity instruments. Equity funds have the potential to offer the highest returns among all classes of mutual funds. The returns provided by equity funds depend on the market movements, which are influenced by several geopolitical and economic factors. The equity funds are further classified as below:
Small-Cap Funds Small-cap funds are those equity funds that predominantly invest in equity and equity-linked instruments of companies with small market capitalisation. SEBI defines small-cap companies as those that are ranked after 251 in market capitalisation.
Mid-Cap Funds Mid-cap funds are those equity funds that invest primarily in equity and equity-linked instruments of companies with medium market capitalisation. SEBI defines mid-cap companies as those that are ranked between 101 and 250 in market capitalisation.
Large-Cap Funds Large-cap funds are those equity funds that invest mostly in equity and equity-linked instruments of companies with large market capitalisation. SEBI defines large-cap companies as those that are ranked between 1 and 100 in market capitalisation.
Multi-Cap Funds Multi-Cap Funds invest substantially in equity and equity-linked instruments of companies across all market capitalisations. The fund manager would change the asset allocation depending on the market condition to reap the maximum returns for investors and reduce the risk levels.
Sector or Thematic Funds Sectoral funds invest principally in equity and equity-linked instruments of companies in a particular sector like FMCG and IT. Thematic funds invest in equities of companies that operate with a similar theme like travel.
Index Funds Index Funds are a type of equity fund having the intention of tracking and emulating the performance of a popular stock market index such as the S&P BSE Sensex and NSE Nifty50. The asset allocation of an index fund would be the same as that of its underlying index. Therefore, the returns offered by index mutual funds would be similar to that of its underlying index.
ELSS An equity-linked savings scheme (ELSS) is the only kind of mutual fund covered under Section 80C of the Income Tax Act, 1961. Investors can claim tax deductions of up to Rs 1,50,000 a year by investing in ELSS.
Debt Mutual Funds Debt mutual funds invest mostly in debt, money market, and other fixed-income instruments such as treasury bills, government bonds, certificates of deposit, and other high-rated securities. A mutual fund is considered a debt fund if it invests a minimum of 65% of its portfolio in debt securities. Debt funds are ideal for risk-averse investors as the performance of debt funds is not influenced much by market fluctuations. Therefore, the returns provided by debt funds are very much predictable. The debt funds are further classified as below:
Dynamic Bond Funds Dynamic Bond Funds are those debt funds whose portfolio is modified depending on the fluctuations in the interest rates.
Income Funds Income Funds invest in securities that come with a long maturity period and therefore, provide stable returns over time. The average maturity period of these funds is five years.
Short-Term and Ultra Short-Term Debt Funds Short-term and ultra short-term debt funds are those mutual funds that invest in securities that mature in one to three years. These funds are ideal for risk-averse investors.
Liquid Funds Liquid funds are debt funds that invest in assets and securities that mature within ninety-one days. These mutual funds generally invest in high-rated instruments. Liquid funds are a great option to park your surplus funds, and they offer higher returns than a regular savings bank account.
Gilt Funds Gilt Funds are debt funds that invest in high-rated government securities. It is for this reason that these funds possess lower levels of risk and are apt for risk-averse investors.
Credit Opportunities Funds Credit Opportunities Funds mostly invest in low-rated securities that have the potential to provide higher returns. Naturally, these funds are the riskiest class of debt funds.
Fixed Maturity Plans Fixed maturity plans (FMPs) are close-ended debt funds that invest in fixed income securities such as government bonds. You may invest in FMPs only during the fund offer period, and the investment will be locked in for a predefined period.
Balanced or Hybrid Mutual Funds Balanced or hybrid mutual funds invest across both equity and debt instruments. The main objective of hybrid funds is to balance the risk-reward ratio by diversifying the portfolio. The fund manager would modify the asset allocation of the fund depending on the market condition, to benefit the investors and reduce the risk levels. Investing in hybrid funds is an excellent way of diversifying your portfolio as you would gain exposure to both equity and debt instruments. The debt funds are further classified as below:
Equity-Oriented Hybrid Funds Equity-oriented hybrid funds are those that invest at least 65% of its portfolio in equities while the rest is invested in fixed-income instruments.
Debt-Oriented Hybrid Funds Debt-oriented hybrid funds allocate at least 65% of its portfolio in fixed-income instruments such as treasury bills and government securities, and the rest is invested in equities.
Monthly Income Plans Monthly income plans (MIPs) majorly invest in debt instruments and aim at providing a steady return over time. The equity exposure is usually limited to under 20%. You can decide if you would receive dividends on a monthly, quarterly, or annual basis.
Arbitrage Funds Arbitrage funds aim at maximising the returns by purchasing securities in one market at lower prices and selling them in another market at a premium. However, if the arbitrage opportunities are not available, then the fund manager may choose to invest in debt securities or cash equivalents.