Mutual Funds

A mutual fund is a pool of money, which is collected from many investors and is invested by an asset management company to achieve some common objectives of the investors.In practice, funds are generally distinguished from each other based on their investment objectives and the type of securities that they invest. The broad classification is as follows:

1) Debt Fund

 A scheme, which invests in debt securities, is known as a debt fund. An important fact worth noticing here is that a fund with only major part of its fund invested in debt couldn’t be termed as a debt fund. A debt fund, which invests nearly all its assets in debt securities, is also called as an Income Fund. In Indian mutual fund markets, various asset management companies have come out with schemes which have an investment pattern of 85%-93% in debt and remaining (around 7%-15%) in equity. These funds are popularly called as Monthly Income Plan (MIP). MIPs are preferred by investors because they generate regular income in the form of dividend. Debt securities comprises of long-term instruments such as bond issues by central and state governments, public sector organizations, public financial institutions and private sector companies; and short-term instruments such as call money lending; commercial papers, certificates of deposits and treasury bills. The aim of income funds is to provide regular and steady income to investors.

Debt funds can be sub-classified in the following ways:

 1.a) Diversified Debt Fund

 These funds invest in a portfolio of debt securities issued by entities across all industries and sectors. The fund manager has the freedom to choose from the universe of debt securities: government and others as well as long and short-term.

1.b) Gilt Fund

 ‘Gilt’ stands for government securities with medium to long term maturity typically more than one year. Gilt funds invest its money in government securities. Government securities do not carry any credit risk. These funds invest in long and short-term securities issued by the government.

1.c) Liquid / Money Market Fund

Money market mutual funds generally invest in instruments with maturities of less than a year. The investment portfolio is very liquid, and enables investors to hold their investments for very short horizons of a day or more. The fund pre-dominantly invests in money market instruments and provides investors the returns that are available on these instruments. These funds invest in short-term interest bearing securities like treasury

bills issued by governments, certificates of deposits issued by banks and commercial papers issued by companies.

         1.d)  Fixed Maturity Plan

 A fixed maturity plan, popularly known as an FMP is a closed-end fund that invests in debt and money market instruments of the same maturity as the stated maturity of the plan. The focus of an FMP is to provide a stream of income through interest payments, while exposing the investor to a lower level of risk.

2) Balanced Fund

 A balanced fund, also known as hybrid fund is a fund that invests in both equity (shares) and debt (fixed return investments) in comparable proportion. The proportion need not be exactly same but comparable. A balanced fund tends to provide investors exposure to both equity and debt markets in one single product. It gives an investor exposure in equity at a relatively lower volatility. The aim of balanced funds is to provide both growth and regular income.

 3) Equity Fund

 A scheme, which invests predominant portion of its fund in equity and equity related instruments, is known as an equity scheme. This kind of a scheme exhibits all the attributes of an equity instrument viz., it has comparatively high risk, high return potential and extremely volatile. An investor entering an equity fund should understand that he is taking risk and should be prepared to remain invested in such a scheme for a long tenure. The aim of growth funds is to provide capital appreciation over the medium to long- term.

Equity funds can be sub-classified in the following ways:

3.a) Diversified Equity Fund

 This fund invests in equity across all sectors, companies. These funds invest a predominant portion of funds mobilized in equity and equity related products. These funds have the freedom to invest both in primary and secondary markets for equity.

Equity Linked Saving Scheme (ELSS): This is a diversified equity scheme, which gives an investor benefit from tax point of view. In India, on investing in this scheme, the investor gets reduction from taxable income to the extent of amount invested. However, this deduction is subject to a maximum limit of rupees one lakh. The investor will be subject to a lock-in period of three years.

3.b) Sectorial Fund

 The investment objective of a sectorial fund is to invest in securities of a specific sector. The choice of the sector could vary depending on the investor preference and the return-risk attributes of the sector. Investors who want to participate in any specific sector can do so, by investing in the particular sectorial fund. Sectorial funds are not as well diversified as diversified equity funds, as they tend to focus on fewer sectors in the equity markets. They can exhibit very volatile returns.

Few examples are:

  • Banking Sector Fund
  • Information Technology (IT) Sector Fund
  • Fast Moving Consumer Goods (FMCG) Sector Funds

3.c) Index Fund

 This is an approach based on passive style of fund management. In this approach, the fund manager does not take call of the individual stocks. Rather the focus is on creating a diversified equity portfolio that simply replicates an existing market index. In order to track the return performance of markets, market indices of a sub-set of trading stocks is created. The CNX Nifty is one such index of 50 large and liquid stocks. If a fund manager creates an equity fund, which will invest in the NIFTY stocks, in the same proportion as in the index, he is creating an index fund. The costs of this strategy are lower and the fund performance virtually tracks the market index. An index fund provides an ideal exposure to equity markets, without the investor having to bear the risks and costs arising from the market views that a fund manager many take.

Apart from the above classification of mutual funds, there are a few other funds available in the market, which are:

  • Fund of Funds (FOF)

A fund of funds invests in the schemes of other mutual funds. But, a normal mutual fund scheme can’t invest in any FOF scheme. Also, an FOF scheme, can’t invest in another FOF scheme. It is also not allowed to invest its assets other than in schemes of mutual funds, except to the extent of its liquidity requirements towards purchases or redemptions, as disclosed in its offer document.

  • Opportunity Fund

It is a fund that invests across sectors and within sector, where ever opportunity exists. Also, it has a flexibility to invest across market

capitalization. As markets evolve and grow, new opportunities of growth keep emerging and an opportunity fund has the ability to grab those opportunities, as and when they exist.

  • Contrarian Fund

Mutual funds that follow contrarian investment strategy are called contrarian funds. A contrarian investment strategy is one which focuses on undervalued stocks and this is a concept of investing which usually entails careful research and then choosing to look for areas of the market that are being neglected and have a high growth potential in future.

  •  Equity Linked Debentures (ELDs)

These are structured products which give you the upside of equities and protect the downside. They are popularly known as capital protection funds. In other words, ELDs are floating rate debt instruments whose coupon (interest) is based on the return of the underlying equity index.

  •  Exchange Traded Fund

Exchange Traded Funds are essentially Index Funds that are listed and traded on exchanges like stocks. An ETF is a basket of stocks that reflects the composition of an Index, like S&P CNX Nifty or BSE Sensex. The ETFs trading value is based on the net asset value of the underlying stocks that it represents; meaning thereby, that it is a mutual fund that can be bought and sold in real-time at a price that changes throughout the day.

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