Mutual Funds | Types & Categories

Mutual funds are used for goal planning by many investors. However, it totally depends upon what type of mutual fund scheme you choose. Previously, we have discussed 4 main types of mutual funds, but it also has sub-categories and types based on asset classes & size of companies or market capitalization.

Market Capitalization

It can be calculated by multiplying company’s stock price by its outstanding shares. For example, Reliance has 1000 outstanding shares, and its share price is Rs.100, then Reliance market capitalization will be Rs.100000 (Rs.1000*100). Following are the different types of mutual funds:

Based on Market Capitalization

A) Large Cap Funds: These funds invest money in large companies. It gives stability and good returns over time. Companies in these funds perform better in the time of recession. It includes top 100 stocks by market capitalization like HDFC Bank, Reliance, TCS, Infosys etc. Generally, these stocks have higher valuation than others. As per SEBI norms, large-cap fund managers are required to invest 80% of its total assets in large-cap stocks.

B) Mid Cap Funds: These funds invest in mid-size companies. Mid-cap stocks trades at lower valuation but have higher growth potential than large-cap stocks. Mid-cap stocks can become large-cap stocks in future. It has potential to give higher returns than large cap stocks. It includes 101^st to 250^th stocks by market capitalization. As per SEBI norms, mid-cap fund managers are required to invest 65% of its total assets in mid-cap stocks.

C) Small Cap Funds: These funds invest in small size companies. Small-cap stocks are more risky than large-cap and mid-cap stocks. They are volatile in the market and have less liquidity. These companies also have higher risk of failure. These stocks outperform large-cap and mid-cap in the time of economic boom. 251^st and next small, micro stocks includes in these funds. As per SEBI norms, small-cap fund managers are required to invest 65% of its total assets in small-cap stocks.

D) Flexi Cap Funds: These funds invest across different stocks by market capitalization i.e., large-cap, mid-cap, and small-cap companies. It provides diversification and exposure to investors by making investment in different companies. As per SEBI norms, flexi-cap fund managers are required to invest 75% of its total assets in equity with minimum 25% to each large, mid and small-cap stocks.

Index Funds

It is a type of mutual funds which replicate the underlying index performance i.e., Nifty 50 or BSE Sensex. These funds have low expense ratio & are not actively managed. Generally, they do not outperform the market. Investors who don’t have much knowledge or time but want to participate in market should invest in these funds. Suppose Nifty 50 index has given return of 10% in one year, so index fund named SBI Nifty 50 Index Fund will also give 9.8-9.9% return. The difference is due to tracking error and expense ratio.

ETF

Exchange-Traded Funds (ETFs) are like index funds which replicate the indices. The main difference is that it can be traded or can be bought and sold throughout trading day like stocks. It is a basket of securities that are traded on stock exchange. The price of each ETF unit is changed on demand and supply in market. It has a lower cost of transactions. You must have a Demat account to trade in ETFs. Categories of ETFs:
I) Equity ETF
II) Gold ETF
III) Debt ETF
IV) International ETF

ELSS

Many investors don’t know that they can get tax deductions by investing in mutual funds known as Equity Linked Saving Scheme (ELSS). These funds allow an individual for deduction up to Rs.1.5 Lakh under section 80C of Income Tax act. But it has lock-in-period of 3 years. ELSS provides dual benefits of tax taxing and capital appreciation. Also, there is no maximum limit to invest. Any person who has basic knowledge, taking risk of equities and stays invested for long term ELSS is best suitable for them. Also, these funds are managed by professional fund managers, so investors’ active participation is not required.

Sectoral Funds

These mutual funds invest in specific sector or industry like Information Technology (IT), Banking, Pharma, Real Estate, Energy etc. stocks. It has a high-growth potential, but high returns come with high risk. As per SEBI norms, these funds must invest minimum 80% of its assets in specified sector stocks. For example,
a) Tata Digital India Fund invests in IT companies like Infosys, TCS, HCL Tech, Mahindra Tech, Wipro etc.
b) Tata Banking & Financial Services Fund invests in banking and NBFC stocks like HDFC Bank, ICICI Bank, SBI Bank, Bajaj Finance, Bajaj Finserv etc.

Thematic Funds

It invest in a particular theme like affordable housing, rural consumption etc. It is less risky because it invests in multiple sectors around the theme. As per SEBI norms, these funds must invest minimum 80% of its assets in particular theme stocks. For example,
a) Affordable housing theme include metals, cements, infrastructure, finance companies. So, fund manager will invest in stocks like Tata Steel, Ambuja Cements, DLF, HDFC Bank etc. stocks.
b) Rural consumption theme include tractors, fertilizers, FMCG, power companies. So, fund manager will invest in stocks like Escorts, Chambal Fertilizers, Dabour, Tata Power etc., stocks.

International Funds

Many investors want to invest in international companies like Facebook, Apple, Amazon, Netflix, Google etc., but they can’t invest in these stocks directly because they are not listed in India. However, this can be achieved by investing in international or overseas mutual funds. Investors get the benefit of geographic diversification and cost-effectiveness. Despite this, currency risk and political situation risk comes along while investing in these funds. Nippon India US Equity Opportunities Fund is an example of international mutual fund.

Arbitrage Funds

This scheme of mutual funds take the advantage of price changes in stocks to buy and sell. The fund manager buys shares in cash market and sells in future market. Basically, it takes the advantage of price difference between spot and future market. What you earn is difference between buying and selling price. For e.g., Wipro share is trading at Rs.550 on BSE & Rs.552 at NSE. You can book profit of Rs.2 by simultaneously buying it on BSE and selling on NSE.

Dividend Yield Funds

For many investors dividend is an important factor while investing in equity. Many companies share a portion of their profits with their shareholders in the form of dividend. In Dividend Yield Funds, fund manager invests in stock which have excellent dividend payout track record. The fund manager must invest 80% of its assets in these stocks. If you are conservative or risk averse investor and want a passive income or cash flow you can add it to your portfolio.

Disclaimer: Mutual Fund investments are subject to market risks, please read all scheme related documents carefully.