Mutual Funds can be defined as money pooled by a large number of people (Investors) having one common investment objective. It can be simply understood as an investment fund collected from a large number of investors and then invested in different stocks, securities, and money market instruments by the professionals known as Fund Managers. The entire fund collected and invested is divided into smaller parts known as ‘Units‘. ‘Units’ are then allotted among the various investors in proportion to the amount invested by them. For the purpose of distributing the return, Net Asset Value or NAV is calculated, on the basis of which the return earned is distributed among all the investors in proportion to the number of ‘units’ held by them.
Types of Mutual Funds
Mutual Funds can be categorized on the basis of types of securities opted, investment goals, risk factors, and so on.
1. On the Basis of Structure
On the basis of the structure, mutual funds are divided into three categories, namely:
Open-Ended Mutual Funds are the ones that can be purchased and sold as per the need and convenience of the investors. They are sold at the prevailing Net Asset Value (NAV) and are considered highly liquid investments. The units of this fund are bought and sold on a continuous basis so, the Net Asset Value (NAV) is calculated on the daily basis, when the markets close. There is no limit to the amount of investment and can be easily managed through Systematic Investment Plans (SIPs).
Close-ended Mutual Funds can be bought only till the New Fund Offer (NFO) is opened. Further, they come with a fixed maturity date and can be redeemed only on the expiry of such date. This means there is a restriction in the entry and exit of the investors in this type of fund and hence, cannot be managed through Systematic Investment Plans (SIPs). In order to compensate for the lack of liquidity,close-ended mutual funds trade on the stock exchange.
Interval Funds pop up to bridge the gap between Open-Ended Mutual Funds and Close-Ended Mutual Funds. With the features of both types of mutual funds, interval funds are offered to new investors only during the New Fund Offer (NFO) period and then can be repurchased only by the existing Mutual Fund House at regular intervals during the tenure of the fund Interval Funds comes with a maturity date like a Close-Ended Mutual Funds. However, investors can manage and adjust their holdings by selling them on the Stock Exchange.
2. On the Basis of Asset Class
Asset Class means grouping the securities having similar characteristics and are falls under the same Laws and Regulations. Depending on the type of asset class, Mutual Funds are divided into:
Equity Funds invest in the equity shares of different companies. The Mutual Fund Company pools the money of different investors together and then invests them into the equity shares of the different companies as per the investment goal of the investors. Equity Funds are associated with high risk and the return depends on the performance of these shares on the stock exchange.
B. Debt FundsÂ
Debt Funds invest the money of the investors in fixed-income securities like debentures, bonds, and treasury bills. These securities offer fix interest and come with a maturity date. Debt funds are suitable for investors willing to take a low risk and want to earn a regular income. Fixed Maturity Plans (FMPs), Gilt Funds, Liquid Funds, Short-Term Plans, Long-Term Bonds, and Monthly Income Plans are some of the fixed-income instruments in which debt funds invest.
Money Market Funds invest in money market instruments like bonds, T-bills, commercial paper (CP), and certificates of deposits (CDs). Money Market Funds are short-term investments with a maturity period of up to 1 year. These funds are the highly liquid and safest form of investment that yields better returns with minimal risk.
D. Hybrid Funds
As the name suggests, Hybrid Funds are a combination of equity and debt. It invests in a portfolio that consists of equity and debt securities in a specific ratio. Generally, Hybrid funds invest in equities and debt in a ratio of 40:60. The return and risk associated with each type are balanced against each other.
3. On the Basis of Investment Objective
Investors with different investment objectives can opt for any of the following mutual fund types:
A. Growth Funds
Growth Funds invest in shares and growth sectors that appear promising enough to yield high returns with capital appreciation opportunities. However, everything has a bad side as well, so this fund is associated with a high degree of risk factor making it suitable for people ready to bear the risk.
B. Fixed-Income Funds
Fixed-Income Funds are a type of debt fund that invest money of the investors in a portfolio consisting of debentures, bonds, securities, and certificates of deposits that yields a fixed return. The fund manager under this fund ensures capital protection along with offering regular income at minimum risk.
C. Tax-Saving Funds
Tax-Saving Funds are the ones that help in wealth maximization along with saving taxes. Such funds enjoy deduction under section 80 of the Income Tax Act and are known as Equity Linked Saving Scheme (ELSS). Tax-saving funds have gained popularity in recent years not just because it offers tax-saving benefits, but also because it comes with a minimum lock-in period of only 3 years.
Liquid Funds also belong to a category of debt funds and invest in debt and money market instruments for a very short period of 91 days. The main motive is to provide high liquidity with low risk and moderate return. The maximum investment amount is up to ₹ 10,00,000 under this fund. The Net Asset Value (NAV) for these funds is calculated for the whole year (365 days) including the holidays and Sundays.
E. Pension Funds
Pension Funds is a long-term hybrid fund that offers a regular return to investors after retirement. The equity component of the fund yields a high return while the debt component balances the risk of investment. Pension Funds are made to secure the after-retirement life and investors have the option to withdraw the return in lum-sum or fixed proportion or in a combination of both.
4. On the Basis of Specialty
On the basis of a specific sector, SEBI has categorized the following Mutual Funds as specialty funds:
Sector Funds are designed to make investments in a particular sector only like the Production sector, Banking, Automobiles, IT, and pharma sector. Since these funds invest in specific and few securities, they are associated with high risk and high return factors. Investors should keep track of all the changing trends related to the sector to minimize the risk.
Index Mutual Funds are the types of mutual funds that track the securities and their corresponding ratio in the market index and make asset allocations accordingly. They are best for passive investors and require low management. Index mutual funds opt for an investment portfolio that is at least 95% similar to the index tracking result.
C. Funds of Funds
Funds of Funds also known as Multi-Manager Funds are designed to avail the benefits of diversified investment by investing in a single fund rather than investing in several. This means the Fund of funds invests in other mutual funds and the return depends on the performance of the target fund. Funds of Funds are considered safer as the portfolio is diversified and adjusted regularly by the managers to balance the risk.
Commodity Mutual Funds invest in physical commodities like gold, silver, oil, or agricultural products or invest in companies involved in their production, exploration, or distribution, with an aim to track the price movements of the underlying commodity. The return depends on the performance of the commodity or the company dealing in the commodity. This fund offers the benefits of diversified investment with a good return.
E. Inverse Funds
Inverse Funds Also known as Leveraged Funds is a sister of an Index fund. The difference between the two is that Index Fund makes asset allocations in accordance with the benchmark index, but inverse fund works in the opposite direction,i.e., it focuses on selling more securities when the value falls just to buy them again at more low cost and to hold them till the price of the security rises again.
5. On the Basis of Risk
Risk is an integrated part of any type of investment, so the Mutual funds are divided on the basis of the degree of risk involved:
A. Low-Risk Fund
A low-risk fund invests in a liquid fund or short-term fund that is known for its low risk and moderate return. However, a low-risk fund doesn’t claim No-Risk, there is always some risk involved. Low-risk funds do not have any lock-in period and are highly liquid. This fund includes debt funds, money market instruments, government Bonds, Ultra short-term investments, and so on. This fund is suitable for people with a minimum risk-taking attitude.
B. Medium-Risk Fund
Medium-Risk Fund targets the hybrid portfolio that consists of the combination of both equity and debt fund. The hybrid fund yields high returns along with balancing the risk of investment. The lock-in period of a moderate-risk fund is generally three to five years.
C. High-Risk Fund
High-Risk Fund earns more return as compared to any other funds. However, the return on such funds is unpredictable and uncertain. It is often disbelieved that High-risk funds mean equity funds, but debt funds with a low rating are also considered high-risk funds.
Share your thoughts in the comments
Please Login to comment...