A comprehensive guide to mutual funds covering asset class, investment goals, structure, risk, and specialised options for investors.
When it comes to investing in mutual funds, one of the most critical decisions an investor faces is choosing the right asset class. Each asset class carries its own unique set of characteristics and risks. In this guide, we will delve into the four primary classifications of mutual fund scheme types based on asset class, exploring the opportunities they present and the risks they entail.
Four Primary Classifications of Mutual Fund Scheme Types
Equity Funds
Equity funds, also known as stock funds, are designed for those seeking to capitalise on the potential high returns offered by the stock market. These funds pool money from diverse investors and invest primarily in shares or stocks of various companies. The performance of these funds is intrinsically tied to the fluctuations of the stock market. When the stocks soar, the funds reap significant gains, but during market downturns, losses can also be substantial.
Investing in equity funds demands a willingness to tolerate higher risk, as market volatility can be unpredictable. However, over the long term, equity funds have the potential to yield substantial returns. They are particularly suitable for investors with a long-term investment horizon who can weather short-term market fluctuations.
Debt Funds
Debt funds are a safe haven for risk-averse investors who prioritise a regular income stream with minimal exposure to market volatility. These funds predominantly invest in fixed-income securities such as bonds, treasury bills, and other debt instruments. Unlike equity funds, the returns from debt funds come from fixed interest rates and the maturity date of the underlying securities.
Debt funds offer stability and are an excellent option for passive investors seeking steady income and capital appreciation. They are less susceptible to market fluctuations, making them an attractive choice during uncertain economic conditions. However, it’s important to note that the returns from debt funds are typically lower than those from equity funds.
Money Market Funds
For investors seeking low-risk, short-term investment options, money market funds provide an ideal solution. These funds invest in money market securities like bonds, T-bills, and certificates of deposits, issued by the government in collaboration with financial institutions and corporations. Money market funds are designed to provide investors with a safe and easily accessible place to park their cash.
By opting for a short-term plan, usually not exceeding 13 months, investors can significantly reduce the risk associated with money market funds. These funds are well-suited for those who prioritise liquidity and want to safeguard their principal amount while earning a modest return.
Hybrid Funds
As the name suggests, hybrid funds strike a balance between equity and debt funds, offering investors the best of both worlds. These balanced funds typically invest in a combination of stocks and bonds, with the ratio between the two asset classes varying based on the fund’s objective.
Hybrid funds appeal to investors who seek a mix of steady income from debt instruments and the potential for higher returns from equity investments. The asset allocation can be adjusted by fund managers, making it suitable for those who want a tailored investment approach.
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Mutual Fund Scheme Types Based on Investment Goals
Mutual funds, as versatile investment instruments, offer a diverse range of options tailored to specific investment goals. Understanding the various types of mutual funds based on investment objectives is crucial in aligning your financial aspirations with the right investment strategy. Let’s explore these funds and their suitability for different investors:
Growth Funds
Targeted towards investors, especially the younger generation with surplus funds, growth funds focus on capital appreciation by investing primarily in shares and growth-oriented sectors. While these funds carry a higher level of risk due to their exposure to equities, they have the potential to deliver substantial returns over the long term. Growth funds are suitable for individuals seeking higher returns and are willing to tolerate market volatility.
Income Funds
Income funds, belonging to the debt mutual fund family, allocate their funds to a mix of debt instruments such as bonds, certificates of deposits, and securities. Managed by skilled fund managers, these funds maintain a balance between yield and creditworthiness. Income funds historically have provided better returns compared to traditional deposits, making them ideal for risk-averse investors with a moderate investment horizon of 2-3 years.
Liquid Funds
As a subset of debt funds, liquid funds invest in short-term debt instruments and money market securities with a tenure of up to 91 days. These funds offer high liquidity and are an excellent option for investors looking to park surplus cash temporarily. Liquid funds differ from other debt funds in the way their Net Asset Value (NAV) is calculated, being based on all 365 days of the year, including Sundays.
Tax-Saving Funds (ELSS)
Equity Linked Saving Scheme (ELSS) has gained popularity among investors for its dual benefit of wealth maximisation and tax savings. These funds predominantly invest in equities and related products and come with a lock-in period of only three years. ELSS has the potential to deliver tax-free returns in the range of 14-16%, making them an attractive choice for salaried individuals with long-term investment goals.
Aggressive Growth Funds
Designed for investors willing to take on higher risks in pursuit of significant returns, Aggressive Growth Funds focus on high-growth opportunities. These funds may have higher volatility, and their market movement is often measured using the beta metric. A higher beta indicates a greater sensitivity to market fluctuations. These funds are suitable for investors who can withstand market ups and downs while seeking substantial gains.
Capital Protection Funds
For risk-averse investors prioritising capital protection, Capital Protection Funds strike a balance between equities and debt instruments. These funds aim to preserve the principal amount while providing relatively moderate returns (around 12% on average). It is advised to remain invested for a minimum of three years to benefit from the tax advantages and safeguard your capital.
Fixed Maturity Funds (FMP)
Ideal for investors seeking stability and fixed returns, Fixed Maturity Plans invest in various debt instruments with a fixed maturity period, similar to fixed deposits (FDs). FMPs provide the advantage of triple indexation, reducing the tax burden for investors. These closed-ended funds suit individuals cautious about market trends and associated risks.
Pension Funds
Securing your financial future after retirement is essential, and pension funds offer a reliable solution. By regularly contributing to a chosen pension fund, individuals can accumulate wealth over time, ensuring financial stability during retirement. Relying solely on savings might not suffice, and investing in pension funds, such as the Employee Provident Fund (EPF) or other schemes offered by banks and insurance firms, can help meet future contingencies.
Mutual Fund Scheme Types Based on Structure
When it comes to mutual funds, investors are presented with a variety of choices, each catering to different preferences and investment goals. One of the significant classifications is based on the fund’s structure, which determines the flexibility of buying and selling individual mutual fund units. Let’s explore the three primary types of mutual funds based on structure: open-ended funds, closed-ended funds, and interval funds.
Open-Ended Funds
Open-ended funds offer investors unparalleled flexibility and convenience. These funds have no constraints on the number of units that can be traded or the duration for which they can be held. Investors can buy and sell units at any time, based on prevailing Net Asset Values (NAVs). As a result, the unit capital of open-ended funds is continually changing, reflecting the inflow and outflow of investments.
One of the key advantages of open-ended funds is the ease of liquidity, allowing investors to exit their investments whenever needed. However, fund managers have the discretion to stop accepting new investors if the fund size becomes unmanageably large. This helps maintain the fund’s performance and protects existing investors.
Closed-Ended Funds
In contrast to open-ended funds, closed-ended funds have a pre-defined number of units available for purchase. The fund company cannot issue more units beyond the predetermined limit. These funds may also have a New Fund Offer (NFO) period during which investors can buy units. Once the NFO period expires, no additional units are issued, and the fund remains closed for further investments.
Closed-ended funds typically have a fixed maturity tenure, and investors can exit the scheme only when it reaches maturity. However, to provide liquidity to investors, fund managers have the option to either repurchase units or list the fund on stock exchanges, allowing investors to trade their units.
Interval Funds
Interval funds combine features of both open-ended and closed-ended funds, offering a unique investment option. These funds are open for purchase and redemption only during specific intervals, as determined by the fund house. The rest of the time, the fund remains closed for transactions. Additionally, interval funds impose a minimum holding period, usually lasting for at least two years.
Interval funds are suitable for investors seeking short-term financial goals and looking to save a lump sum amount within a specific timeframe, such as 3 to 12 months. The periodic intervals for transactions provide a balance between liquidity and stability, making them attractive for certain investment strategies.
Based on Risk
When it comes to mutual funds, risk plays a crucial role in determining the potential returns and suitability for investors. Understanding the various types of mutual funds based on risk levels is essential for making informed investment decisions. Let’s delve into the four primary classifications of mutual funds based on risk:
Very Low-Risk Funds
For risk-averse investors looking to preserve capital and achieve short-term financial goals, very low-risk funds provide a safe haven. Liquid funds and ultra-short-term funds, with a tenure ranging from one month to one year, fall under this category. Although these funds offer relatively lower returns, usually around 6% at best, they provide high liquidity and stability. Investors choose these funds to park their surplus funds temporarily, ensuring their money remains secure.
Low-Risk Funds
In uncertain economic conditions or times of currency depreciation, risk-averse investors seek refuge in low-risk funds. Fund managers often recommend investing in liquid, ultra-short-term, or arbitrage funds individually or in combination to mitigate risk. Returns from low-risk funds typically range from 6% to 8%, offering a conservative approach to investment. Investors can choose to reallocate their investments to riskier assets when market conditions stabilise.
Medium-Risk Funds
Medium-risk funds strike a balance between risk and return by allocating a portion of the portfolio to debt instruments and the rest to equity funds. This combination provides some level of stability to the Net Asset Value (NAV) while still allowing for the potential to earn higher returns. Investors can expect average returns in the range of 9% to 12%, making medium-risk funds suitable for those seeking moderate growth with a relatively stable NAV.
High-Risk Funds
Investors with a high-risk appetite and a quest for substantial returns often opt for high-risk funds. These funds require active fund management and are exposed to market volatility. While they can yield attractive returns, reaching up to 20%, they demand regular performance reviews to monitor their performance. High-risk funds invest primarily in equity and dividend-oriented securities, making them more susceptible to market fluctuations.
Specialised Mutual Funds
Mutual funds have evolved beyond traditional offerings, with a plethora of specialised funds catering to specific industries and investment objectives. These specialised mutual funds provide unique opportunities for investors seeking targeted exposure to particular sectors or themes. Let’s explore some of these specialised mutual funds and the benefits they offer:
Sector Funds
Sector funds focus on investing solely in one specific sector or industry, making them theme-based Mutual Fund Scheme Types. While they can deliver great returns, investors need to be aware of the higher risk associated with concentrated investments in a single sector. Some sectors, such as banking, IT, and pharma, have shown remarkable growth in recent times and are predicted to continue promising performances in the future.
Index Funds
Suited for passive investors, index funds aim to replicate the performance of a market index without active fund management. These funds invest in stocks based on their respective weightage in the market index. Although they may not outperform the market, index funds offer a safe and low-cost way to mirror the market’s performance.
Funds of Funds
Also known as multi-manager mutual funds, funds of funds invest in various fund categories, creating a diversified mutual fund investment portfolio. This approach allows investors to achieve diversification while minimising costs by buying a single fund that invests in multiple funds.
Emerging Market Funds
Investing in emerging markets, like India, presents higher risk due to market fluctuations, but it also offers the potential for high returns. Emerging economies are expected to contribute significantly to global growth in the coming decades, making emerging market funds an attractive option for investors seeking long-term growth opportunities.
International/Foreign Funds
For investors looking to diversify their investment across countries, foreign mutual funds provide exposure to international markets. Even when the Indian stock market performs well, these funds can offer good returns. Investors can choose from hybrid, feeder, or theme-based allocation approaches to tailor their international exposure.
Global Funds
Distinguished from international funds, global funds invest in markets worldwide, including the investor’s home country. These funds adopt a diverse and universal approach, which can carry higher risk due to varying policies, market dynamics, and currency fluctuations. However, global funds act as a hedge against inflation, and historically, they have offered attractive long-term returns.
Real Estate Funds
For investors hesitant about direct investments in real estate projects, real estate funds provide an alternative. These funds invest in established real estate companies or trusts, offering indirect participation in the real estate sector. With a long-term investment horizon, real estate funds mitigate risks and provide liquidity, making them an appealing choice for real estate exposure.
Mutual Fund Scheme Types FAQs
How Do You Write an MOU?
To write an MOU, clearly outline the parties involved, the purpose of the agreement, and the terms and conditions they agree upon. Be specific about the roles and responsibilities of each party, and ensure both parties understand that the MOU is not legally binding but serves as a framework for future negotiations or contracts.
Why is an MOU Important?
An MOU is important as it establishes a clear understanding between parties, records prior agreements, and provides a framework for future dealings, even though it is not legally binding, it serves as a useful tool in various business and partnership arrangements.
Who writes an MOU or Memorandum of Understanding?
An MOU or Memorandum of Understanding is typically written by the parties involved in the agreement or their legal representatives to outline the terms and intentions of the proposed collaboration or partnership. It serves as a non-binding document to establish a common understanding before proceeding to a formal contract.
