Imagine you and a bunch of your friends all want to invest in the stock market, but you don't have a lot of money to buy a bunch of different stocks all by yourself. So, what you do is you pool your money together with your friends' money to buy a bunch of different stocks as a group. That's kind of what a mutual fund is.
A mutual fund is like a big pot of money collected from many investors like you who want to invest in the stock market or other assets. This big pot of money is managed by a professional called a fund manager. The fund manager's job is to decide which stocks, bonds, or other assets to buy and sell within the fund.
When you invest in a mutual fund, you buy shares of that fund. Each share represents a small piece of the entire pool of investments held by the mutual fund. So, when the value of the investments in the mutual fund goes up, the value of your shares goes up too. And if the value of the investments goes down, the value of your shares goes down as well.
The main idea behind a mutual fund is that by pooling your money with other investors and having a professional manager handle the investments, you can potentially spread out your risk and have a better chance of making money over the long term.
Types of equity mutual funds schemes
There are various ways of categorising equity funds. Here is a look at the different categorizations:
Investment strategy based categorization
Thematic or sectoral funds - These funds invest at least 80% investment in stocks of a particular sector/ theme like international stocks, emerging markets, BFSI, IT, or pharmaceuticals. These funds carry higher risk due to their narrow focus on a particular sector or theme.
Dividend yield fund - It primarily focuses on investing in stocks or securities of companies with a history of paying high dividends relative to their share price. These funds are designed to provide investors with regular income in the form of dividends along with the potential for capital appreciation.
Value fund - The fund follows a value investing strategy. Value investing involves selecting stocks that are deemed to be undervalued relative to their intrinsic worth or fundamental value. These funds aim to capitalise on the potential for these undervalued stocks to appreciate over time as their market prices align more closely with their true value.
Focused equity fund - This fund focused on the number of stocks with a maximum of 30 with at least 65% in equity & equity related instruments.
Contra equity fund - As the name suggests, these schemes follow a contrarian investment strategy with at least 65% in stocks. These schemes analyse the market to identify undervalued stocks and acquire them at discounted prices, anticipating their long-term recovery.
Tax treatment based categorization
Equity linked savings scheme - ELSS stands out as the sole equity scheme providing tax benefits of up to ₹1.5 lakh under Section 80C of the Income Tax Act. These schemes allocate a minimum of 80% of total assets to equity and equity-related instruments. Moreover, they entail a lock-in period of 3 years.
Non-tax saving equity fund - except for ELSS, all other equity funds fall under the non-tax saving category. This implies that returns from these schemes are subject to capital gains tax.
Market capitalisation based categorization
Large-cap funds - It primarily invests in companies with the highest market capitalization, typically those ranked from 1 to 100 on the Indian stock exchange. As per SEBI regulations, large-cap funds are required to allocate a minimum of 80% of the fund's total assets to equity and equity-related instruments of large-cap companies.
Mid-cap funds - They typically invest in companies with a market capitalization ranging from ₹5,000 crore to ₹20,000 crore. These companies are ranked between 101 and 250 based on market capitalization within an index. As per SEBI regulations, mid-cap funds are required to allocate a minimum of 65% of the total fund assets to equity and equity-related instruments of mid-cap companies.
Small-cap funds - They primarily invest in companies with a market capitalization below ₹5,000 crore. These companies typically rank below the 250th position in terms of market capitalization within an index. According to SEBI regulations, small-cap funds must allocate a minimum of 65% of the total assets to investments in small-cap companies. Small-cap funds are well-suited for investors seeking high-risk opportunities and are comfortable with the inherent volatility associated with these investments.
Multi-cap funds - They provide investors with the advantage of diversifying their investments across equity shares of large-cap, mid-cap, and small-cap companies. According to SEBI guidelines, multi-cap funds are required to invest a minimum of 25% of their corpus in each of the categories: large-cap, mid-cap, and small-cap companies. The allocation of the remaining 25% is at the discretion of the fund manager. These funds are ideal for investors seeking diversification across various sectors and aiming to mitigate risk in their investment portfolios.
Flexi-cap funds - Akin to multi-cap funds, have the flexibility to invest in companies across all market capitalization sizes. However, flexi-cap funds offer additional flexibility to the fund manager. They can choose to avoid mid and small-cap stocks entirely if they prefer. Moreover, they have the freedom to allocate a larger portion of the portfolio to large-cap stocks, especially during periods of economic downturn or market volatility.
In flexi-cap funds, there are no set limits on the percentage of funds that the manager can allocate to each category, whether large-cap, mid-cap, or small-cap. This flexibility allows the fund manager to adapt the portfolio composition based on market conditions and investment strategies. However, as per the SEBI, the fund has to make at least 65% investments in equity and equity related instruments.
Large and mid-cap fund - It is a type of mutual fund that invests in a combination of large-cap and mid-cap companies stocks. These funds provide investors with exposure to a diversified portfolio comprising both large and mid-sized companies. However, as per the SEBI guidelines, the fund has at least 35% investment in large-cap stocks and 35% in mid-cap stocks.
In conclusion, equity mutual funds offer investors the opportunity to participate in the growth potential of the stock market while benefiting from the expertise of professional fund managers. These funds pool money from multiple investors and invest primarily in stocks or equity-related instruments. However, investors should conduct thorough research, assess their risk tolerance, and align their investment objectives before investing in equity mutual funds.
Rohit Gyanchandani is Managing Director at Nandi Nivesh Private Limited
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