Different Types of Mutual Funds

This article talks about different types of mutual funds available in the Indian market.

A mutual fund is an investment vehicle that pools the money collected from various investors to invest in securities such as stocks, bonds, money market securities, and other assets. Mutual Funds are professionally managed by fund managers, who try to allocate funds’ assets to generate capital gains and income for the investors. Mutual Funds are gaining huge popularity among Indian investors due to a range of benefits offered by it such as flexibility, diversification, expert management, liquidity, SIP option, and so on. In India, mutual funds are regulated by the Securities and Exchange Board of India (SEBI), which classifies mutual funds based on where they invest. But mutual funds can also be classified in other ways. This wide range of classification is designed to satisfy the diverse risk appetites of the investor. Among different types of mutual funds, investors can choose the schemes based on their investment amount, risk, goals, investment tenure, and other factors. Let us discuss different types of mutual funds.

Types of Mutual Funds based on their Structure

1. Open-ended Mutual Funds: Through open-ended schemes, investors can invest or redeem their money anytime without any constraints. These schemes are highly liquid in nature and have no specific maturity period. Investors can conveniently trade units of their mutual funds at Net Asset Value (NAV) related prices. Commonly, most mutual funds are open-ended in nature.

2. Closed-ended Mutual Funds: Closed-ended schemes have a specified investment period investors can invest in such schemes only during the initial offer period known as New Fund Offer (NFO). There is a fixed maturity period before which investors can not redeem their funds. Generally, Closed-ended funds are listed on stock exchanges to provide liquidity to them. In some closed-ended schemes, investors have the option to sell back their units to the mutual fund issuer through periodic repurchase. According to SEBI, investors must be provided with at least one exit route.

3. Interval Mutual Funds: Interval schemes simply allow investors to invest and redeem in such schemes at intervals. These can be understood as closed-ended schemes with certain windows in between to enter and exit the mutual fund scheme. It has features of both open-ended and closed-ended mutual funds.

Types of Mutual Funds based on Asset Class

1. Equity Funds: Equity mutual fund schemes pool the money of investors to invest in the stocks or shares of companies. These funds are considered high-risk and thus have the potential for high returns. These funds invest at least 65% of their portfolio in equity stocks or other equity-related securities. Equity mutual funds offer a great opportunity to young and experienced investors to diversify their portfolios with different equity funds such as large-cap, small-cap, mid-cap, growth stocks, income funds, and so on. Equity funds are advised for long-term goals.

2. Debt Funds: Debt mutual fund schemes invest their portfolio mainly in fixed-income instruments like government and corporate bonds. Debt funds tend to offer stable but low returns and suffer from low market risk. These funds are ideal for investors with a low-risk tolerance, who is looking for a stable source of income. However, these funds are subject to credit risk.

3. Money Market Funds: Money market mutual fund schemes primarily invest in liquid instruments like T-Bills, Commercial Papers, and so on. These funds are a safe investment option for those looking to park their surplus funds for a very short time period, generating immediate and moderate returns. These funds suffer from interest risks, reinvestment risks,s and credit risks. The average maturity period of such funds is one year. These funds offer a good option to investors to diversify their portfolios while generating good returns.

4. Balanced or Hybrid Funds: A hybrid fund scheme invests in a mix of asset classes. These funds offer investors exposure to both equity and debt investments. The asset allocation keeps changing based on market conditions and risks. Hybrid funds aim to balance the risk and rewards by investing in diverse asset classes. Though balanced funds are not entirely risk-free, they offer a good option to investors seeking maximum capital gain with minimal risks.

Type of Mutual Funds based Investment Objectives

1. Growth Funds: Growth fund schemes aim to generate capital appreciation for their investors. These funds are usually well diversified with a considerable portion in equity shares and growth sectors. These funds are considered risky, ideal for investors with long-term investment goals.

2. Income Funds: Income fund schemes primarily aim is capital protection and generating regular income for their investors. These funds invest mainly in fixed-income instruments like bonds and debentures. It is best suited for risk-averse investors.

3. Liquid Funds: Liquid fund schemes’ primary aim is to provide liquidity to their investors. These funds invest in short and very short-term instruments like T-Bills, CPs, etc. It is considered a low-risk investment providing moderate returns.

4. Tax-Saving Funds (ELSS): Tax-saving funds or Equity Linked Saving Schemes (ELSS) invest in equity shares of different companies. An investment made in these funds qualifies for tax deductions u/s 80C of the Income Tax Act,1961. These funds are considered high-risk, offering high returns. It has a lock-in period of 3 years and is thus suited for long-term investments.

5. Pension Funds: Pension fund schemes aim to provide a regular income source to investors post their retirements. These funds have a very long-term goal. The investments in these funds may be split between equities and debts. Investors can withdraw their returns either in lump-sum, as a pension, or a combination of both options.

Types of Mutual Funds based on Return Option

1. Growth Option: Under the growth option, the profits made by the mutual funds would be invested back into the scheme for which the Net Asset Value (NAV) of each unit of the mutual fund goes up. Similarly, in the event of loss, NAV goes down. Thus, investors will have to redeem the units to get any profits out of the growth option of the mutual fund.

2. Dividend Option: Under the dividend option, the profits made by the mutual funds are distributed to the investors at regular intervals. The profit distributed is deducted from the Net Asset Value (NAV) of each mutual fund unit.

Types of Mutual Funds based on Specialty

1. Sector Funds: Sector funds invest in a particular sector of the market. As investment is made in a particular sector, the performance of such funds is also tied to the performance of such a sector. The risk involved in these funds is derived from the nature of the sector.

2. Index Funds: Index funds invest in market instruments that are representative of a particular index on a stock exchange. These funds try to mirror the movement and returns of a particular index.

3. Emerging Market Funds: Emerging market funds invest in stocks of developing countries. These funds focus on stocks of countries undergoing economic transitions and showing good potential for future growth. It is a high-risk investment due to dynamic economic and political situations in such countries.

4. Gilt Funds: Gilt Funds invest in government securities for long time horizons. These funds are considered virtually riskless and are ideal for risk-averse investors.

There can be several other specialty mutual funds such as International Funds, Fund of Funds, Real Estate Funds, Market Neutral Funds, Leveraged Funds, Exchange Traded Funds, and so on.

Summary: Choosing the Right Mutual Fund

There are so many different types of mutual funds available in the market based on different attributes. It is not an easy job for an investor to pick the right mutual funds for them. As a first step investors should understand their needs. Then they need to figure out their specific goals, whether it is wealth creation, regular income, or something else. After setting goals, investors should decide on their risk appetite. Investors should always carefully read the policy documents of mutual funds before investing in them as they list the various risk associated with the fund. Therefore, investors should choose mutual funds only after considering their needs, goals, risks, and policy document of the fund.