Mutual funds have grown considerably in popularity in India after their introduction in 1963. Some of the reasons so many investors prefer these investment vehicles are their diversified portfolio, expert money management, flexibility, etc.
There are many types of mutual funds in the country, catering to different investors’ needs. Some of these types depend on asset allocation (equities, debt, or hybrid), fund management (active or passive), or structure (open-ended or closed-ended). So, you can find the right investment option regardless of what you are looking for.
The following sections will cover various mutual fund categories based on multiple criteria.
Based on the Underlying Asset Class
Here are the different types of mutual funds based on the underlying asset class:
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Equity funds
These mutual funds invest at least 65% of their assets in stocks or other equity-related instruments. Equity funds come with the risks of short-term volatility but offer the chance to get high returns.
Equity mutual funds are suitable for investors with a high-risk appetite and a long-term investment horizon. These come in various types depending on their market capitalization or investment style.
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Debt funds
Debt mutual funds invest primarily in debt instruments like government securities, treasury bills, corporate bonds, debentures, deposits, etc. As debt funds invest in fixed income instruments offering a specific interest rate, these schemes provide more stable returns than other types of mutual funds.
Debt funds can be further categorized based on the maturity period of assets or types of securities held.
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Hybrid Funds
Hybrid mutual funds invest in asset classes like equity, debt, etc., to offer you a diversified portfolio. The ratio of asset distribution can vary depending on the type of hybrid funds. Hybrid funds aim to offer a balance between risks and returns. While equity assets offer high potential returns, debt instruments provide regular and stable income.
Types of mutual funds Based on the Structure
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Open-ended mutual funds
Investors can sell or purchase units of these schemes throughout the year. The purchase or redemption of open-ended funds occurs at the prevailing Net Asset Value (NAV). Moreover, there is no limit on the total investment amount of these investment options. Open-ended funds tend to be highly liquid as investors can enter and exit their investments.
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Close-ended mutual funds
These mutual funds have a fixed maturity date so that you can redeem units only after this period. You can purchase units of these schemes only during the NFO (new fund offer) period. Close-ended schemes come with a maturity period. Investors who want to exit the scheme before the maturity period can choose to sell their units on stock exchanges.
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Interval mutual funds
A cross between open-ended and close-ended schemes, this kind of mutual fund allows purchase and redemption only during specific intervals. Like close-ended funds, units of interval funds are also listed on the stock exchanges.
Based on Portfolio Management Style
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Active funds
Fund managers of these types of mutual funds ‘actively’ rebalance the portfolio to provide returns better than their benchmark. They use various strategies to select the most suitable securities and decide on buying, selling, or holding them.
The risks and returns of these schemes depend on their investment strategy, as described in the Scheme Information Document. The fund manager’s expertise also plays a vital role in the performance of active schemes.
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Passive funds
In the case of passive funds, the fund manager does not actively manage the funds. They aim to mimic the composition of the scheme’s underlying benchmark with minimal tracking error. Changes happen to the portfolio only when there is a change in the index’s composition.
There are only two types of passive mutual funds in India — Index funds and ETFs. Passive funds offer the benefit of increased transparency and affordability.
Based on the Investment Objectives
The following are the different types of mutual funds based on a scheme’s investment objective:
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Growth mutual funds
These mutual funds are designed to offer high capital appreciation. Growth funds invest primarily in stocks and are ideal for investors with a high-risk appetite looking for significant gains over a medium-long term investment horizon.
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Liquid mutual funds
These mutual funds are for investors looking for principal protection and high liquidity. Overnight funds, ultra short-term funds, liquid funds and money market funds are examples of these schemes. Investors looking to park their surplus cash for the short term can invest in this mutual fund.
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Income mutual funds
Income funds are ideal for investors looking for steady and regular income. These invest in debt instruments like government securities, corporate bonds, and debentures for a fixed income. The returns from these funds depend on the credit quality of securities and their maturity period.
Equity Linked Savings Scheme (ELSS) Funds is the only type of tax-saving mutual fund. These invest in different equity shares and have a lock-in period of 3 years. Investments in ELSS funds are eligible for tax deductions of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act.
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Capital protection funds
These are close-ended hybrid funds that invest in equity derivatives and fixed income instruments. This type of mutual fund scheme primarily invests in debt instruments with the highest credit rating.
Capital protection mutual funds aim to provide capital protection, and their ability to do so is rated by a credit rating agency.
Other Mutual Fund Types
Here are some of the other types of mutual fund schemes offered in India:
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Solution-oriented mutual funds
These schemes make it easier for you to reach certain goals like children’s education or your retirement. Solution-oriented funds come with a lock-in period of 5 years.
There are two different mutual funds of this type in India — retirement funds and children’s funds.
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Other mutual funds
This includes index funds, Fund of Funds (FoFs), and Exchange Traded Funds (ETFs). Index funds are passively-managed funds that track a particular market index. The units of ETFs are listed on the stock exchanges. You can buy or sell ETF units during trading hours.
FoF is a type of mutual fund that invests 95% of the assets in other mutual fund schemes. The schemes selected will depend on the Fund of Fund’s investment objective.
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Types of Equity Mutual Funds
Let’s check out the various types of equity funds:
- Large-cap funds: These are open-ended mutual funds investing a minimum of 80% of assets in equities of large-cap companies. These offer the lowest volatility among equity funds and can generate steady capital appreciation.
- Large and mid-cap funds: These equity funds must invest at least 35% of their assets in large-cap companies and 35% in mid-cap companies.
- Mid-cap funds: Mid-cap funds invest a minimum of 65% of total assets in stocks of mid-cap companies. These schemes offer better opportunities for returns than large-cap or large and mid-cap funds but carry higher risks.
- Small-cap funds: Small-cap funds invest at least 65% of their assets in equities of small-cap companies, which rank 251st and below in market cap. These have the potential to generate the highest returns but carry the highest risks.
- Multi cap funds: These equity funds must invest at least 25% of assets in large-cap, mid-cap and small-cap stocks. These funds offer the stability of large-cap stocks and returns of mid-cap and small-cap stocks.
- Dividend yield funds: These funds invest at least 65% of total assets in stocks that offer regular and high dividends.
- Sectoral/thematic funds: These types of mutual funds invest a minimum of 80% of assets in equities of a particular sector/theme.
- Value funds: Value funds follow a value investment strategy, i.e. picking stocks with strong fundamentals.
- Contra funds: Contra funds follow the contrarian method, which involves investing in underperforming markets.
- Focused funds: These mutual funds invest 65% of total assets in a limited number of stocks (maximum 30).
- ELSS: ELSS funds invest at least 80% of their total assets in equities and offer tax benefits u/s 80C.
- Flexi cap funds: Flexi cap funds invest at least 65% of the investment corpus in stocks and equity-related instruments. As per the market situation, fund managers of such schemes can alter the proportion of investment in large-cap, small-cap and mid-cap stocks to maximize investors’ returns.
Types of Debt Mutual Funds
The following are the various debt mutual fund categories:
- Corporate bond funds: Corporate bond funds invest a minimum of 80% in corporate bond instruments of the highest ratings.
- Credit risk funds: These debt funds invest at least 65% in corporate bonds with ratings of AA or below. They carry higher risks than most of the other debt funds.
- Gilt funds: These debt funds invest primarily in government securities (minimum 80% of their portfolio) with different maturity periods. Investors who do not want any credit risk prefer gilt funds.
- Banking and PSU funds: These mutual funds invest at least 80% of total assets in bonds, debentures, and certificates of deposits.
- Overnight funds: These invest primarily in overnight securities with residual maturity of 1 day.
- Liquid funds: Liquid funds invest in highly liquid debt and money market instruments like Treasury Bills, deposits (CDs), commercial papers (CPs), call money, etc. These have a maturity period of up to 91 days.
- Ultra-short duration funds: These debt schemes invest in securities with a Macaulay duration of 3 to 6 months. Investors looking for a highly liquid and relatively stable investment can consider investing in them.
- Low duration funds: Low duration funds have a 6 to 12 months Macaulay duration.
- Money market funds: These debt funds invest in money market instruments like CPs, CDs, and T-Bills having a Macaulay duration of up to 1 year.
- Short duration funds: These mutual funds have a Macaulay duration of 1 to 3 years. These offer stable investments with decent returns.
- Medium duration funds: These schemes have a Macaulay duration of 3 to 4 years.
- Medium to long-duration funds: These have a Macaulay duration of 4 to 7 years.
- Long duration funds: These schemes have a Macaulay duration of over seven years. Long-duration funds usually offer high yields but carry interest rate risks.
- Dynamic bond funds: Dynamic bond funds invest in debt instruments with varying maturity periods.
Types of Hybrid Mutual Funds
- Aggressive hybrid funds: Aggressive funds invest primarily (65-80%) of their total assets in stocks. Debt instruments sponsor the rest (20-30%).
- Balanced hybrid funds: These invest 40 to 60% of assets in equities and 40 to 60% in debt instruments.
- Conservative hybrid funds: Conservative funds invest primarily (75-90%) of their total assets in debt instruments. Stocks and related instruments sponsor the rest (10-25%).
- Dynamic asset allocation/balanced advantage funds: The asset allocation for these schemes between equities and debt keeps changing depending on market conditions.
- Arbitrage funds: These invest primarily (at least 65%) in arbitrage opportunities in the equities, cash and futures markets.
- Multi-asset allocation funds: This type of mutual fund invests in at least three asset classes with a minimum 10% allocation for each category.
- Equity savings fund: An equity savings fund invests at least 65% in equities, a minimum of 10% in debt instruments, and the rest in arbitrage opportunities.
Things to Consider When Investing in Mutual Funds
The following are some of the aspects you need to take into account when choosing a mutual fund scheme:
- Risks associated with the investment
- Your financial goals
- The past performance of the fund over multiple market cycles (3, 5, or 10 years)
- The experience and track record of the fund manager and their team
- Costs involved with the fund, including expense ratio and exit load.
- Taxes applicable to different types of mutual funds
- Whether you are purchasing units through a direct plan or a regular plan
Final Word
There are multiple types of mutual funds in India, so you will want to choose the one that suits your risk appetite and financial goals. It would help to consider the tax implications, liquidity, lock-in periods, etc., before investing. Many experts recommend building a diversified portfolio with different mutual funds to minimize the risks and maximize the return potential of your investments.
Frequently Asked Questions
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What is the Macaulay duration of certain mutual funds?
Macaulay duration refers to the time it would take for an investor to get back their principal amount and interest. The Macaulay duration of a debt fund is calculated as the weighted average maturity period of all of its securities.
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What are the tax implications of different types of mutual funds?
Long-term capital gains (LTCG) from equity funds over Rs. 1 lakh in a financial year are taxed at 10%. 15% LTCG tax is applicable on short-term capital gains (STCG) earned from equity funds.
Short-term capital gains are taxed for debt funds as per your applicable tax slab rate. LTCG tax is applicable at a 20% rate for these schemes with indexation benefits.
Hybrid funds with over 65% exposure to equities are taxed like equity funds, and other funds are taxed like debt funds.
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What are the different ways to invest in a mutual fund?
You can invest in mutual funds through the lump sum mode or a Systematic Investment Plan (SIP). The lump-sum method involves making a one-time payment to buy units for a set amount. SIPs involve investing a fixed amount regularly. It builds financial discipline and is a cost-effective mode of investment.
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What type of mutual funds is the safest?
No mutual fund is entirely safe as they are market-linked instruments subject to volatility. That said, various types of mutual funds come with different risk factors. For example, equity funds are highly volatile due to changing stock prices. In contrast, debt funds are associated with less volatility.
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What is the difference between the growth and dividend options of mutual funds?
In the case of the growth option, returns from a mutual fund are reinvested back into the scheme. You can get around these gains plus your principal investment only when you redeem the units.
In the case of the dividend option, you can get dividends from the scheme at regular intervals (monthly, quarterly, or annually).
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