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Different Types of Mutual Funds and its Benefits

Written by - Akshatha Sajumon

January 12, 2022 12 minutes

There are many sources through which an investor can explore different markets, and securities and mutual funds are some of those vehicles to drive funds into the market to buy securities like stocks, bonds, and other money market instruments. Mutual funds come in many varieties that meet various investment objectives. 

Here is a primer on all the types of mutual funds available in the Indian market. 

Mutual fund categories based on the structure

  1. Open-ended funds: Funds with no lock-in period are called open-ended funds. That means investors can enter or exit from the mutual fund scheme at any time. In these funds, there would be no limitations on the number of units the fund can issue. They don’t have a fixed maturity period, but that doesn’t mean there would be no charges. An investor has to pay an exit load if exited before one year. Liquidity is the main advantage of open-ended funds.
  2. Close-ended funds: Unlike the above funds, closed-end funds have a fixed maturity period. That means investors cannot enter or exit from the scheme at any time. The fund house cannot issue an unlimited number of units. If any new investor wants to buy units from these funds, they have to find the seller for those units in the stock exchange. These schemes are traded on the stock exchanges. Since the transactions are taking place between two investors, there would be no involvement of the fund house.
  3. Interval Funds: Interval funds combine the features of open and close-ended funds. In a year, during most of the month’s interval funds behave like close-ended funds. They behave like an open-ended scheme during the intervals of January 1 – 15 and July 1 – 15. During these intervals, investors can buy units from the fund house. But outside these intervals, the investor needs to depend on the stock exchange and have to find a seller to buy the units.
    The period during which the open-end scheme is available is called a transaction period and the remaining part of the year is called an interval period.

Mutual fund categories based on the style of management

  1. Actively Managed Funds: These are the funds for which a fund manager manages the portfolio of these funds. These fund managers aim to beat the benchmark index, so they are involved in active research and buying and selling of stocks for the portfolio. Since these funds are actively managed by the fund manager, investors can expect higher charges.
  2. Passive Funds: There are fund managers for passive funds, but they are not actively involved in picking stocks. These funds track indexes like Nifty or Sensex since passive funds track indexes and mirror the index’s composition. Index funds, Fund of Funds are some of the examples of passive funds.

Mutual fund categories based on assets they invest in

Mutual funds invest in various asset classes like equities, debt, gold, etc. 

Equity mutual funds 

In equity schemes, the funds are allocated to buy equity and equity-related investments. The main goal of these schemes is capital appreciation through the growth in the underlying assets. There are many funds under equity schemes, but the most important criteria for choosing a particular fund is market capitalisation.

All the funds which are mentioned below are open-ended

  1. Large-cap fund: Fund houses under this scheme choose to invest the funds in large, blue-chip companies which offer stable returns. 1st to 100th companies was considered a large-cap in terms of market capitalisation
  2. Mid-cap fund: Fund houses under this scheme choose to invest the funds in the companies which have the potential for faster growth and higher returns. The stocks under mid-cap funds can be more vulnerable to an economic slowdown and stock prices fall significantly when compared to large-cap funds. 101 to 250 companies are considered mid-cap companies
  3. Small-cap fund: Fund houses under this scheme choose to invest in companies whose capitalisation is low when compared to mid-cap funds. The “251st company and further” are considered small-cap companies. These are more vulnerable than large and mid-cap funds in case of economic lows. The stock prices of these companies have the potential for fast appreciation and depreciation. Small-cap funds are highly risky and suitable for aggressive investors.
  4. Large and mid-cap fund: Invests in both large and mid-cap companies. Of total assets, the fund house has to invest a minimum of 35% in equity or equity-related instruments of large-cap and another 35% in mid-cap companies.
  5. Multi cap fund: In multi-cap funds, the fund house invests across various large, mid, and small-cap stocks. The minimum investment in equity-related instruments should be 65%.
  6. Dividend yield fund: This is also an open-ended fund. In dividend yield funds, the fund house invests in stocks that have a good dividend yield. In this fund also the minimum investment in equity or equity-related instruments should be 65%.
  7. Contra fundContra funds are also called value funds. These fund houses follow a contra or a value investment strategy. In simpler terms, they identify the small and mid-cap stocks that have huge growth potential in an upward direction. Like the above two funds, in this too, the fund house should invest a minimum of 65% in equity or equity-related instruments.
  8. Thematic and sectoral fundsUnlike other funds, thematic funds invest only in particular themes like consumption, rural, infrastructure while sectoral funds invest in sectors like auto, banks, pharma, etc. Out of total assets, the fund house has to make sure that 80% of them should be in equity or equity-related products.
  9. Equity-linked savings scheme (ELSS): This is the most famous among salaried people. ELSS schemes under section 80C come with a lock-in period of 3 years. Out of total assets, 80% should be in equity or equity-related instruments.

Debt  Mutual Funds

Debt funds are differentiated based on debt securities the fund house invests in. The differentiation is based on the holding period of the securities (short term or long term) and the issuer (corporate, government, etc). The risk in debt funds is defined based upon the tenor and issuer.

Debt funds categories based upon the tenure

  1. Overnight funds  –  These schemes invest in debt securities, which have a maturity of just one day. These funds come with the least amount of interest risk.
  2. Ultra short-term schemes –  These are also called treasury management funds. These schemes invest in the money market and short-term securities for a term of three-six months.
  3. Short duration funds – This plan combines short-term debt securities with durations of 6 months to 3 years.
  4. Medium to long-term debt funds – These schemes invest in securities across different durations and hence can be subject to interest rate risks

Debt funds categories based on the assets they invest in

  1. Gilt FundsGilt funds are funds where investment is entirely in government securities. These funds are considered to be relatively safer funds as the government securities have no risk of default. The NAV of these funds is nevertheless subject to fluctuations on account of changes in interest rates or other economic factors.
  2. Corporate Bond funds: These are another type of debt fund that invests predominantly in corporate bonds. The minimum investment required by the fund in corporate bonds is 80%. These bonds are considered low-risk bonds and are ideal for risk-averse investors looking for more or less stable returns at relatively low risk.
  3. Banking & PSU funds: These debt mutual funds invest in banking and PSU companies and these are construed to be much safer.

Categories of Debt funds based on investment strategy

Just like equity funds have different investment strategies, debt funds also come with different investment strategies. Some of them are

  1. Income fund: Income funds are those funds that aim to provide returns in rising as well as falling interest scenarios by actively managing the fund portfolio. These funds invest in various sorts of securities like debentures, government securities, corporate bonds, etc. They try to make gains by either holding the security till maturity or selling the security if their price increases.
  2. Junk bond funds: Junk bonds are also a type of debt funds issued based on companies that have no proven track record or have a questionable financial position. The risk involved in such funds is too high as they are considered to be highly volatile in nature.
  3. Dynamic debt funds: These funds invest in debt products that are of different maturity dates. The target investors for this fund are investors with low or moderate risk appetites. The investment horizon for these funds is usually 3 years to 5 years.
  4. Fixed maturity plans: This fund invests in debt instruments that have maturity in line with the maturity of the fund. The maturity of these funds can be a few months or years depending on the guidelines of the fund. The goal of these funds is to provide the investors with better post-tax returns at minimal risk.
  5. Floating rate debt funds: Floating rate funds as the name suggests invests in bonds that have a floating rate of interest. This means that the rate of interest of these instruments is highly influenced by the prevailing interest rates of the economy. Despite being based on instruments having floating rates, these funds are considered to be less volatile and can be included in the fixed income portfolio of the investor.

Hybrid Funds

As the name itself suggests, these funds invest in a combination of asset classes like debt, equity, and gold. These funds aim to give balanced returns to investors as they spread out their investments across various classes. 

Categories of hybrid funds

Hybrid funds invest in various percentages of assets to meet various investment needs of the investors.

  1. Conservative hybrid funds  – Major portion of the portfolio is debt. 75 to 90% of the fund is invested in debt and 25 to 10% invest in equity.
  2. Balanced hybrid funds – Invests equally both in equity and debt securities.
  3. Aggressive hybrid funds – Most of the portfolio comprises equity or equity-related instruments. The minor part belongs to debt securities. Equity comprises 65 – 80% of the total assets and debt – 20 – 35% of total assets.
  4. Capital-protected schemes – These schemes aim to safeguard the capital that is invested. This scheme invests 80% of their corpus in debt funds and the rest in equities. These are mostly close-ended funds.
  5. Multi-Asset allocation funds – These funds invest in various asset classes. They do not specify the minimum and maximum percentage for each asset class.
  6. Arbitrage funds – These funds target neutral risk along with returns. They hedge their portfolio by taking opposite positions in various markets.

Solution-Oriented Funds

Solution-oriented funds are funds that are created to provide solutions for specific requirements like children’s education, retirement, etc.

  1. Children’s fundThis is an open-ended fund with a lock-in period of at least five years or till the maturity age of the child, whichever is earlier.
  2. Retirement fund: This is also an open-ended fund with a lock-in period of at least five years or the retirement age of the individual, whichever is earlier.

Categories of mutual funds with Passive style of investing

The most common type of mutual funds was already mentioned above. But other types do not belong to the above categories. They are

  1. Index Funds: These are open-ended schemes that track a particular index. There would be a small tracking error because returns from these funds are not the same as that index. But the returns match closely. Out of total assets, 95% of stocks should be the same as the index.
  2. Funds of funds: Instead of directly investing in stocks, the fund house invests in other investment funds. This type of fund is called multi-manager funds, where 95% of total assets should be in the underlying fund.

Real estate funds

Some other funds invest in real estate. They are

  1. Real estate mutual fund– Invests in real estate either directly or indirectly. Follows SEBI regulations
  2. Real estate investment trust (REIT) – Invests in commercial real estate and is  registered with SEBI
  3. Infrastructure investment trust (InvIT)- Invests in infrastructure sectors, this is also registered with SEBI

Investors have to understand the nature of the mutual funds before investing in them. This will assure the investors of the returns and the risk factor associated with these funds. It will further assure the investors of their investment and help them make sound investment decisions.

Frequently Asked Questions

1.What are thematic mutual funds?
Thematic mutual funds are funds that invest only in particular sectors like auto, banks, pharma, etc. Out of total assets, the fund house has to make sure that 80% should be invested in equity or equity-related products.

2.Are mutual funds an expensive form of investment?
No, mutual funds are collective investments made by a number of individuals. So the costs get spread among all those people. The expense ratio (cost charged by mutual funds) stands in the range of 0.2- 2.5% depending upon the type of the fund,  which is not expensive for the diversification benefits and the professional management offered by mutual funds.

3.How many mutual funds should I ideally invest in?
As you can see from the list above, there are various types of mutual funds that are offered by mutual fund companies. The number of mutual funds you should invest in should depend upon your investment objectives, tenure, and your risk profile. It is good to diversify, but do not over diversify your investments.

4.Are all mutual funds taxed in the same manner?
No, the taxation on mutual funds differs based on the type of funds you invest in (equity or debt ) and on the duration for which you remained invested. These factors determine whether you would be charged short-term or long-term capital gains on your investments. You could check out our detailed guide on taxation on mutual funds.

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