What is a Mutual Fund?

A Mutual fund is trust that collects money from a number of investors who share a common investment objective and invests the same in equities, bonds, money market instruments and/or other securities. The income/gains generated from this collective investment is distributed proportionately among the investors after deducting applicable expenses and levies, by calculating a scheme’s “Net Asset Value” or NAV. Simply put, the money pooled in by a large number of investors is what makes up a Mutual Fund.

What are the different types of Mutual Fund schemes?

• Schemes according to Maturity Period:

  A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on its maturity period.

  • Open-ended Fund: An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis. These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices after deduction of exit load, if any which are declared on a daily basis. The key feature of open-end schemes is liquidity.
  • Close-ended Fund: A close-ended fund or scheme has a stipulated maturity period e.g. 3 years, 5 years, 10 years etc. The fund is open for subscription only during a specified period at the time of the launch of the scheme. Investors can invest in the scheme at the time of the initial public issue. In order to provide an exit route to investors, some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices. Some close-ended funds are also listed on stock exchanges in order to facilitate liquidity.
• Schemes according to Investment Objective:

  A mutual fund scheme can also be classified as a equity/growth fund, debt/income fund, liquid fund or balanced fund based on its investment objective. Such funds may be open-ended or close-ended as described earlier.

  • Equity/Growth Fund: An equity fund is a mutual fund scheme that invests predominantly in equity stocks. In the Indian context, as per current SEBI Mutual Fund Regulations, an equity mutual fund scheme must invest at least 65% of the scheme’s assets in equities and equity related instruments. Equity mutual funds are principally categorized according to company size, the investment style of the holdings in the portfolio and geography. The size of an equity fund is determined by the market capitalization of the stocks that it invests in, while the investment style, reflected in the fund's stock holdings, is also used to categorize equity mutual funds. Equity funds are also categorized by whether they are domestic (investing in stocks of only Indian companies) or international (investing in stocks of overseas companies). These can be broad market, regional or single-country funds. Some specialty equity funds target business sectors, such as health care, commodities and real estate and are known as Sectoral Funds. An Equity Fund can be actively managed or passively managed. Index funds and ETFs are passively managed.
  • Debt/Income Fund: A debt fund is a mutual fund scheme that invests in fixed income instruments, such as Corporate and Government Bonds, corporate debt securities, and money market instruments etc. Debt funds are also referred to as Income Funds or Bond Funds. Debt funds are ideal for investors who want regular income, but are risk-averse. Debt funds are less volatile and, hence, are less risky than equity funds. If you have been saving in traditional fixed income products like Term Deposits, and looking for steady returns with low volatility, debt mutual funds could be a better option, as they help you achieve your financial goals in a more tax efficient manner and therefore offer potentially superior post-tax returns.
  • Liquid Fund: Liquid Funds as the name suggests, invest predominantly in highly liquid money market instruments and debt securities of very short tenure and hence provide high liquidity. They invest in very short-term instruments such as Treasury Bills (T-bills), Commercial Paper (CP), Certificates Of Deposit (CD) and Collateralized Lending & Borrowing Obligations (CBLO) that have residual maturities of up to 91 days to generate optimal returns while maintaining safety and high liquidity. Redemption requests in these Liquid funds are processed within one working (T+1) day. The aim of the fund manager of a Liquid Fund is to invest only into liquid investments with good credit rating with very low possibility of a default. The returns typically take the back seat as protection of capital remains of utmost importance. Control over expenses in the form of low expense ratio, good overall credit quality of the portfolio and a disciplined approach to investing are some of the key ingredients of a good liquid fund. Most retail customers prefer to keep their surplus cash in Savings Bank deposits as they consider the same to be safest and they could withdraw the money at any time. Liquid Funds and Money Market Mutual Funds provide a more attractive option. Surplus cash invested in money market mutual funds earns higher post-tax returns with a reasonable degree of safety of the principal invested and liquidity.
  • Balanced Fund: A balanced fund combines equity stock component, a bond component and sometimes a money market component in a single portfolio. These funds invest in a mix of equities and debt, giving the investor the best of both worlds. Balanced funds gain from a healthy dose of equities but the debt portion fortifies them against any downturn. Balanced funds are suitable for a medium-term horizon and are ideal for investors who are looking for a mixture of safety, income and modest capital appreciation. The amounts this type of mutual fund invests into each asset class usually must remain within a set minimum and maximum.

What are the advantages of Investing in Mutual Funds?

Investing in mutual funds will offer both retail as well as institutional investors with innumerable advantages over direct investments in the markets:

• Diversification: Mutual funds invest in a basket of securities rather than a few stocks. This offers investors the benefits of diversification as the risk is spread across a number of securities. Even if an investor has a small amount to invest, by investing in a mutual fund, he gets exposure to the entire portfolio of securities as he is part of a larger pool of investors. This is not possible if an investor would invest directly in the stock market.
• Professional Management: Mutual Funds are managed by dedicated fund managers who are responsible for all the investment decisions and monitoring the performance of the fund. The fund managers usually have a wealth of experience and are professionals in the field of portfolio management i.e. their sole job is managing your money!
• Economies Of Scale: Buying individual stocks and bonds is expensive in terms of transactions costs. Mutual funds offer the advantage of economies of scale in purchases and sales because mutual fund transactions are typically large, thereby reducing transaction costs for investors.
• Flexible & Innovative Plans: There is certainly no “one size fits all” formula with Mutual Funds. There are various types of mutual funds to suit all types of investment horizons, liquidity requirements and risk appetites. Mutual Funds also offer the flexibility to switch between plans, options or fund categories keeping in mind that investor requirements change over time.
• Liquidity: Mutual fund investments are also extremely liquid and investor’s in open-ended funds can redeem their investments on any business day. Liquid Fund investors usually receive the money within T+1 working day while investors in other funds can expect to receive their investment proceeds within T+3 working days.
• Transparency: Mutual funds disclose their NAVs on all business days, so performance of mutual funds is extremely transparent and can be tracked very easily, Also, mutual funds disclose their portfolios at the end of every month and the same is displayed on the AMC websites. In addition, most mutual funds regularly communicate with their investors in the form of monthly factsheets, product updates as well as fund manager’s outlook on the markets.
• Tax Benefits: Some mutual fund schemes offer tax benefits under Section 80C of the Income Tax Act which means that an investment in such schemes up to Rs1.5 lakh in exempt from income tax. Furthermore, mutual fund investments offer several tax benefits – All dividends declared by mutual funds is tax free in the hands of the investor; Investments in equity funds over 1 year in exempt from tax while debt fund investments over 3 years is subject to long-term capital gains tax.
• Well Regulated: All mutual funds are governed by SEBI and follow stringent regulations as laid down by the regulator. In addition, mutual funds are subject to several audits to ensure that they are always working as per the regulatory guidelines and in the best interests of unit holders.