Discovering the categories of mutual funds

The penetration of the internet, easily accessible information, and government efforts have significantly increased the number of investors in the mutual fund industry. According to one report, this industry added 20 million accounts last year. Furthermore, asset growth in the Indian mutual fund business has outpaced China, the United States, and Japan.

Despite this rapid expansion, many investors are hesitant to invest because they are unfamiliar with the various types of mutual funds. This article will assist such investors by defining the mutual fund categories. 

Different types of mutual funds

The classification of mutual funds can be done based on the asset class, structure, and investment goals. Here is a detailed discussion of them.

Based on asset class

1. Equity fund 

These funds pool money from investors with similar goals but diverse backgrounds and invest it in the company’s stocks. If the price of the portfolio’s shares rises, you profit; if the price falls, you lose. 

They offer a higher profit potential than other funds on the market because of their high volatility but also carry a higher risk.

2. Debt funds

This fund’s portfolio includes fixed-income securities such as long-term bonds, Gilt funds, monthly income plans, liquid funds, and a few more. These securities are noted for their low risk and stable returns. The maturity period and the interest rate of the securities within the portfolio are also predefined.

3. Money market funds

As the name implies, this fund invests in the money market, or more specifically, the cash market or the capital market. Money market funds’ securities typically have a short maturity duration of fewer than 13 months. Some common examples of money market instruments are: 

• Treasury bills (T-bills): The central government issues them to raise funds for its short-term needs. 
• Commercial paper (CP): They are unsecured promissory notes issued by large corporations to meet their working capital requirements.
• Certificate of deposit (CD): It is a negotiable deposit issued by financial institutions to raise funds for a specified period. 

4. Hybrid funds

Hybrid mutual funds combine equity and debt assets in a single portfolio. They aim to offer a balance of capital appreciation and income generation while reducing the investment’s overall risk. You can opt for this fund if you want to diversify your portfolio across diverse asset classes and have a moderate risk appetite.

The best ratio of a hybrid funds portfolio is 60% allocation in equity or equity-related instruments and the remaining in debt securities.

Based on structure

1. Open-ended funds

Open-ended mutual funds allow you to transact units at any time based on the fund’s prevailing net asset value (NAV). The NAV is computed by dividing the total value of the fund’s assets by the number of units outstanding. These mutual funds do not have a fixed maturity date or a limit on the number of units they can issue. They offer liquidity, flexibility, and diversification to investors. However, the scheme may refuse to accept more investments or investors at the discretion of the Asset Management Company (AMC) or fund manager.

2. Close-ended funds

A close-ended mutual fund has a fixed number of units and a fixed maturity period. Sometimes, you can only purchase the units of this scheme during the New Fund Offer (NFO) period. Once the NFO period ends, the units are listed on an exchange and traded like shares. 

3. Interval funds

These mutual fund schemes in India offer a mix of features of open-ended and closed-ended funds. They allow you to transact units only during specific time intervals the AMC decides. However, it is worth mentioning that you cannot place any transaction for at least two years. 

You may opt for interval funds if you are looking to achieve a short-term goal.

Based on investment goals

1. Growth funds

This scheme invests pooled capital into sectors with high growth potential but with considerable risk. The companies in the portfolio typically reinvest their earnings to expand their business rather than paying dividends to shareholders.

2. Income funds

These funds invest mainly in fixed-income instruments like bonds, debentures, and government securities. The objective of income mutual funds is to provide regular income to investors, along with capital preservation and growth. 

They are most suited for investors approaching retirement, but if you have a low to moderate risk tolerance and wish to augment your current income with consistent returns over the long term, you can also consider this scheme. 

3. Liquid funds

They are debt mutual funds that invest in securities with maturities of up to 91 days. These securities include treasury bills, government securities, call money, commercial paper, and certificates of deposit. 

Liquid funds are considered the safest among all mutual fund categories, as they have minimal interest rates and credit risk. Under this scheme, you can redeem your units within one working day.

The distinguishing feature of liquid funds is that their NAV is calculated over 365 days, while other schemes only consider working days.

4. Aggressive growth funds

They are identical to growth funds, but the companies or sectors the fund manager chooses here are riskier. To understand how volatile these schemes are, here is an example.

Assuming the current market has a beta of 1, an aggressive mutual fund may have a higher beta, typically greater than 1.10.

Beta indicates how responsive a mutual fund is to the fluctuations of its benchmark index.

Conclusion

Now that we have gone over several mutual fund examples, it is crucial to note that each fund has a different risk profile and return potential. Before investing in any scheme, carefully consider your future goals, savings, and risk tolerance. You should also read the SEBI guidelines for mutual funds to avoid any surprises during redemption. To know more, subscribe to StockGro. 

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