A wide variety of Mutual Fund Schemes exists to cater to the needs such as financial position, risk tolerance, and return expectations etc.
Don’t get confused about the below classifications. This is just for reading. In future articles, I will focus on only some specific mutual funds which may be of some interest for the retail investor like me and you.
Types of Mutual Funds: By Structure
1. Open Ended Schemes
An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value (“NAV”) related prices. The key feature of open-end schemes is liquidity.
2. Close Ended Schemes
These schemes have a pre-specified maturity period. One can invest directly in the scheme at the time of the initial issue. Depending on the structure of the scheme there are two exit options available to an investor after the initial offer period closes. Investors can transact (buy or sell) the units of the scheme on the stock exchanges where they are listed. The market price at the stock exchanges could vary from the net asset value (NAV) of the scheme on account of demand and supply situation, expectations of unit holder and other market factors. Alternatively some close-ended schemes provide an additional option of selling the units directly to the Mutual Fund through periodic repurchase at the schemes NAV; however, one cannot buy units and can only sell units during the liquidity window. SEBI Regulations ensure that at least one of the two exit routes is provided to the investor.
3. Interval Schemes
Interval Schemes are that scheme, which combines the features of open-ended and close-ended schemes. They are largely close-ended but become open-ended at pre-specified intervals. The units may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices.
Types of Mutual Funds: By Nature
1. Equity fund
These funds have the investment objectives to invest largely in equity shares and equity-related investments like convertible debentures. These funds invest a maximum part of their corpus into equities holdings. The structure of the fund may vary different for different schemes and the fund manager’s outlook on different stocks.
The Equity Funds are sub-classified depending upon their investment objective, as follows:
Diversified Equity Funds
Mid-Cap Funds
Sector Specific Funds
Thematic Fund
Tax Savings Funds (ELSS)
Equity Income/Dividend Yield Fund
Arbitrage Funds
Equity investments are meant for a longer time horizon, thus Equity funds rank high on the risk-return matrix.
2. Debt funds
The objective of these Funds is to invest in debt papers. Government authorities, private companies, banks and financial institutions are some of the major issuers of debt papers. By investing in debt instruments, these funds ensure low risk and provide stable income to the investors.
Debt funds are further classified as:
Gilt Funds: Invest their corpus in securities issued by Government, popularly known as Government of India debt papers. These Funds carry zero Default risk but are associated with Interest Rate risk. These schemes are safer as they invest in papers backed by Government.
Income Funds: Invest a major portion into various debt instruments such as bonds, corporate debentures, and Government securities.
Short Term Plans (STPs): Meant for investment horizon for three to six months. These funds primarily invest in short-term papers like Certificate of Deposits (CDs) and Commercial Papers (CPs). Some portion of the corpus is also invested in corporate debentures.
Fixed Maturity Plans (FMP): are a kind of debt fund where the investment portfolio is closely aligned to the maturity of the scheme. AMCs tend to structure the scheme around pre-identified investments. Further, like close-ended schemes, they do not accept money post-NFO. Thanks to these characteristics, the fund manager has a little ongoing role in deciding on the investment options.
Floating rate funds: invest largely in floating rate debt securities i.e. debt securities where the interest rate payable by the issuer changes in line with the market. For example, a debt security 16 where interest payable is described as ‘5-year Government Security yield plus 1%’, will pay interest rate of 7%, when the 5-year Government Security yield is 6%; if 5-year Government Security yield goes down to 3%, then only 4% interest will be payable on that debt security. The NAVs of such schemes fluctuate lesser than debt funds that invest more in debt securities offering a fixed rate of interest.
Liquid Funds: Also known as Money Market Schemes, These funds provide easy liquidity and preservation of capital. These schemes invest in short-term instruments like Treasury Bills, inter-bank call money market, CPs, and CDs. These funds are meant for short-term cash management of corporate houses and are meant for an investment horizon of 1-day to 3 months. These schemes rank low on the risk-return matrix and are considered to be the safest amongst all categories of mutual funds.
3. Balanced funds:
As the name suggests they, are a mix of both equity and debt funds. They invest in both equities and fixed income securities, which are in line with the pre-defined investment objective of the scheme. These schemes aim to provide investors with the best of both the worlds. Equity part provides growth and the debt part provides stability in returns. Further, the mutual funds can be broadly classified on the basis of investment parameter viz, Each category of funds is backed by an investment philosophy, which is pre-defined in the objectives of the fund. The investor can align his own investment needs with the funds objective and invest accordingly.
4. Hybrid Funds
Monthly Income Plans (MIP): Invests maximum of their total corpus in debt instruments while they take minimum exposure in equities. It gets benefit of both equity and debt market. These scheme ranks slightly high on the risk-return matrix when compared with other debt schemes.
Capital Protection Oriented Schemes: are close-ended schemes, which are structured to ensure that investors get their principal back, irrespective of what happens to the market. This is ideally done by investing in Zero Coupon Government Securities whose maturity is aligned to the scheme’s maturity. (Zero coupon securities are securities that do not pay a regular interest, but accumulate the interest, and pay it along with the principal when the security matures). As detailed in the following example, the investment is structured, such that the principal amount invested in the zero-coupon security, together with the interest that accumulates during the period of the scheme would grow to the amount that the investor invested at the start.
5. Fund of Funds
The feeder fund was an example of a fund that invests in another fund. Similarly, funds can be structured to invest in various other funds, whether in India or abroad. Such funds are called fund of funds. These ‘Funds of Funds’ pre-specify the mutual funds whose schemes they will buy and/or the kind of schemes they will invest in. They are designed to help investors get over the trouble of choosing between multiple schemes and their variants in the market.
By investment objective:
Growth Schemes: Growth Schemes are also known as equity schemes. The aim of these schemes is to provide capital appreciation over the medium to long-term. These schemes normally invest a major part of their fund in equities and are willing to bear short-term decline in value for possible future appreciation.
Income Schemes: Income Schemes are also known as debt schemes. The aim of these schemes is to provide regular and steady income to investors. These schemes generally invest in fixed income securities such as bonds and corporate debentures. Capital appreciation in such schemes may be limited.
Balanced Schemes: Balanced Schemes aim to provide both growth and income by periodically distributing a part of the income and capital gains they earn. These schemes invest in both shares and fixed income securities, in the proportion indicated in their offer documents (normally 50:50).
Money Market Schemes: Money Market Schemes aim to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer, short-term instruments, such as treasury bills, certificates of deposit, commercial paper and inter-bank call money.
Other schemes
Tax Saving Schemes: Tax-saving schemes offer tax rebates to the investors under tax laws prescribed from time to time. But, these ELSS funds will have a lock-in period of 3-Years.
Index Schemes: Index schemes attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50. The portfolio of these schemes will consist of only those stocks that constitute the index. The percentage of each stock to the total holding will be identical to the stocks index weightage. And hence, the returns from such schemes would be more or less equivalent to those of the Index.
Sector Specific Schemes: These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are riskier compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time.
Exchange Traded Funds (ETF): Exchange Traded Funds (ETF) are open-ended index funds that are traded on a stock exchange. A feature of open-ended funds, which allows investors to buy and sell units from the mutual fund, is made available only to very large investors in an ETF. Other investors will have to buy and sell units of the ETF in the stock exchange. In order to facilitate such transactions in the stock market, the mutual fund appoints some intermediaries as market makers, whose job is to offer a price quote for buying and selling units at all times.
If more investors in the stock exchange want to buy units of the ETF, then their money would be due to the market maker. The market maker would use the money to buy a basket of securities that are in line with the investment objective of the scheme and exchange the same for chapters of the scheme from the mutual fund. Thus, the market maker can offer the units to the investors. If there is more selling interest in the stock exchange, then the market maker will end up with units, against which he needs to make payment to the investors. When these units are offered to the mutual fund for extinguishment, corresponding securities will be released from the investment portfolio of the scheme.
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