Mutual Funds

Diversified equity fund is a category of funds that invest in a diverse mix of securities that cut across sectors and market capitalization. The risk of the fund’s performance being significantly affected by the poor performance of one sector or segment is low.

Market Segment based funds invest in companies of a particular market size. Equity stocks may be segmented based on market capitalization as large- cap, mid-cap and small-cap stocks.

Large- cap funds invest in stocks of large, liquid blue-chip companies with stable performance and returns.

Mid-cap funds invest in mid-cap companies that have the potential for faster growth and higher returns. These companies are more susceptible to economic downturns and evaluating and selecting the right companies becomes important. Funds that invest in such companies have a higher risk of the companies selected not being able to withstand the slowdown in revenues and profits. Similarly, the price of the stocks also fall more when markets fall.

Small-cap funds invest in companies with small market capitalisation with intent of benefitting from the higher gains in the price of stocks. The risks are also higher.

Sector funds invest in only a specific sector.

For example, a banking sector fund will invest in only shares of banking companies. Gold sector fund will invest in only shares of gold-related companies.

The performance of such funds can see periods of under-performance and out-performance as it is linked to the performance of the sector, which tend to be cyclical.

Entry and exit into these funds need to be timed well so that the investor does not invest when the sector has peaked and exit when the sector performance falls. This makes the scheme more risky than a diversified equity scheme.

Thematic funds invest in line with an investment theme.
For example, an infrastructure thematic fund might invest in shares of companies that are into infrastructure construction, infrastructure toll-collection, cement, steel, telecom, power etc. The investment is thus more broad-based than a sector fund; but narrower than a diversified equity fund and still has the risk of concentration.

Strategy-based Schemes have portfolios that are created and managed according to a stated style or strategy.

Equity Income / Dividend Yield Schemes invest in securities whose shares fluctuate less, and the dividend represents a larger proportion of the returns on those shares. They represent companies with stable earnings but not many opportunities for growth or expansion. The NAV of such equity schemes are expected to fluctuate lesser than other categories of equity schemes.

Value fund invest in shares of fundamentally strong companies that are currently under-valued in the market with the expectation of benefiting from an increase in price as the market recognizes the true value. Such funds have lower risk. They require a longer investment horizon for the strategy to play out.

Growth Funds portfolios feature companies whose earnings are expected to grow at a rate higher than the average rate. These funds aim at providing capital appreciation to the investors and provide above average returns in bullish markets. The volatility in returns is higher in such funds.

Focussed funds hold portfolios concentrated in a limited number of stocks. Selection risks are high in such funds. If the fund manager selects the right stocks then the strategy pays off. If even a few of the stocks do not perform as expected the impact on the scheme’s returns can be significant as they constitute a large part of the portfolio.

Equity Linked Savings Schemes (ELSS) are diversified equity funds that offer tax benefits to investors under section 80 C of the Income Tax Act up to an investment limit of Rs. 150000 a year. ELSS are required to hold at least 80% of its portfolio in equity instruments. The investor’s the investment is subject to lock-in for a period of 3 years during which period it cannot be redeemed, transferred or pledged.
Rajiv Gandhi Equity Savings Schemes (RGESS) too, offers tax benefits to first-time investors. Investments are subject to a fixed lock-in period of 1 year, and flexible lock-in period of 2 years.

These funds invest in highly liquid money market instruments and provide easy liquidity. The period of investment in these funds could be as short as a day.
They aim to earn money market rates and could serve as an alternative to corporate and individual investors, for parking their surplus cash for short periods. Returns on these funds tend to fluctuate less when compared with other funds

Earlier known as Liquid Plus Funds, they invest in very short term debt securities with a small portion in longer term debt securities. Most ultra short term funds do not invest in securities with a residual maturity of more than 1 year. Also referred to as Cash or Treasury Management Funds, Ultra Short Term Funds are preferred by investors who are willing to marginally increase their risk with an aim to earn commensurate returns. Investors who have short term surplus for a time period of approximately 1 to 9 months should consider these funds.

These funds primarily invest in floating rate debt securities, where the interest paid changes in line with the changing interest rate scenario in the debt markets. The periodic interest rate of the securities held by these products is reset with reference to a market benchmark. This makes these funds suitable for investments when interest rates in the markets are increasing.

Debt-oriented Hybrid invest primarily in debt with a small allocation to equity. The equity allocation can range from 5% to 30% and is stated in the offer document. The debt component is conservatively managed to earn coupon income, while the equity component provides the booster to the returns.

Monthly Income Plan is a type of debt-oriented hybrid fund seeks to declare a dividend every month. There is no guarantee that a dividend will be paid each month. The term ‘Monthly Income’ is a bit of a misnomer and investor needs to study the scheme properly, before presuming that an income will be received every month.

.Equity-oriented Hybrid funds invest primarily in equity, with a portion of the portfolio invested in debt to bring stability to the returns. A very popular category among the equity-oriented hybrid funds is the Balanced Fund. These schemes were historically launched for the purpose of giving an investor exposure to both equity and debt simultaneously in one portfolio. The objective of these schemes was to provide growth and stability (or regular income), where equity had the potential to meet the former objective and debt the latter. The balanced funds can have fixed or flexible allocation between equity and debt. One can get the information about the allocation and investment style from the Scheme Information Document.

Real Estate Mutual Funds invest in real estate either in the form of physical property or in the form of securities of companies engaged in the real estate business. SEBI’s regulations require that at least 35% of the portfolio should be held in physical assets. Securities that these funds can invest in include mortgage-backed securities and debt issuances of companies engaged in real estate projects. Not less than 75% of the net assets of the scheme shall be in physical assets and such securities. Assets held by the fund will be valued every 90 days by two valuers accredited by a credit rating agency. The lower of the two values will be taken to calculate the NAV. These funds are closed-end funds and have to be listed on a stock exchange.

Real Estate Investment Trusts (REIT) are trusts registered with SEBI that invest in commercial real estate assets. The REIT will raise funds through an initial offer and subsequently through follow-on offers, rights issue and institutional placements. The value of the assets owned or proposed to be owned by a REIT coming out with an initial offer will not be less than Rs. 500 crore and the minimum offer size will not be less than Rs.250 crore. The minimum subscription amount in an initial offer shall be Rs. 2 lakh. The units will be listed on the stock exchange.

These funds invest in gold and gold-related securities. They can be structured in either of the following formats:

Gold Exchange Traded fund, which is like an index fund that invests in gold, gold receipts or gold deposit schemes of banks. Each ETF unit typically represents one gram of gold. For every unit of ETF issued, the fund holds gold in the form of physical gold of 99.5 % purity or gold receipts. They are also allowed to invest in the gold deposit schemes of banks to a limit of 20% of the net assets of the scheme. The NAV of such funds moves in line with gold prices in the market.

Gold funds invest in the units of Gold Exchange Traded Funds. They operate just like other mutual funds as far as the investor is concerned.

Gold Sector fund will invest in shares of companies engaged in gold mining and processing. Though gold prices influence these shares, the prices of these shares are more closely linked to the profitability and gold reserves of the companies. Therefore, NAV of these funds do not closely mirror gold prices.
As with gold, such funds can be structured as Commodity ETF or Commodity Sector Funds. In India, mutual fund schemes are not permitted to invest in commodities, other than Gold (which was discussed earlier). Therefore, the commodity funds in the market are in the nature of Commodity Sector Funds, i.e. funds that invest in shares of companies that are into commodities. Like Gold Sector Funds, Commodity Sector Funds too are a kind of equity fund.

International funds invest in markets outside India, by holding certain foreign securities in their portfolio. The eligible securities in Indian international funds include equity shares of companies listed abroad, ADRs and GDRs of Indian companies, debt of companies listed abroad, ETFs of other countries, units of index funds in other countries, units of actively managed mutual funds in other countries. International equity funds may also hold some of their portfolios in Indian equity or debt. They can also hold some portion of the portfolio in money market instruments to manage liquidity. The overseas investment limit for resident individuals has gone up to US$ 125,000 per year.

One way for the fund to manage the investment is to hire the requisite people who will manage the fund. Since their salaries would add to the fixed costs of managing the fund, it can be justified only if a large corpus of funds is available for such investment.

An alternative route would be to tie up with a foreign fund (called the host fund). If an Indian mutual fund sees potential in China, it will tie up with a Chinese fund. In India, it will launch what is called a feeder fund. Investors in India will invest in the feeder fund. The moneys collected in the feeder fund would be invested in the Chinese host fund. Thus, when the Chinese market does well, the Chinese host fund would do well, and the feeder fund in India will follow suit.
Such feeder funds can be used for any kind of international investment, subject to the scheme objective. The investment could be specific to a country (like the China fund) or diversified across countries. A feeder fund can be aligned to any host fund with any investment objective in any part of the world, subject to legal restrictions of India and the other country.
In such schemes, the local investors invest in rupees for buying the Units. The rupees are converted into foreign currency for investing abroad. They need to be re-converted into rupees when the moneys are to be paid back to the local investors. Since the future foreign currency rates cannot be predicted today, there is an element of foreign currency risk.
It is clear that the investor's total return in such schemes will depend on how the international investment performs, as well as how the foreign currency performs. Weakness in the foreign currency can pull down the investors' overall return. At the same time, appreciation in the respective currency will boost the portfolio performance.

A Fund of Funds (FoF) is a mutual fund that invests in other mutual funds. It does not hold securities in its portfolio, but other funds that have been chosen to match its investment objective. These funds can be either debt or equity, depending on the objective of the FoF. A FoF either invests in other mutual funds belonging to the same fund house or belonging to other fund houses. FoFs belonging to various mutual fund houses are called multi-manager FoFs, because the AMCs that manage the funds are different. A FoF looks for funds that fit into its investment objective. It specialises in analyzing funds, their performance and strategy and adds or removes funds based on such analysis. A FoF imposes additional cost -on the investor, as the expenses of the underlying funds are built into their NAV.

Exchange Traded funds (ETF) are open-ended funds, whose units are traded in a stock exchange. Investors buy units directly from the mutual fund only during the NFO of the scheme. Al further purchase and sale transactions in the units are conducted on the stock exchange where the units are listed. The mutual fund issues further units and redeems units directly only in large lots defined as creation units.

The unique structure of ETFs, make them more cost-effective than normal index funds, although the investor would bear a brokerage cost when he transacts with the market maker and need to have a demat account into which the units of the ETF will be credited.