Types of mutual funds in India: An overview

Mutual funds can be a suitable way to build wealth over time, offering several advantages to investors. They are diversified, which means they invest in multiple securities to spread risk. They are professionally managed, so you do not need financial expertise to invest. Moreover, they have a low barrier to entry – you can start investing with as little as Rs. 100 or Rs. 500.

However, there are many types of mutual funds available in India, each with different characteristics, risk levels, and return potential. Knowing the various types of mutual funds is essential for investors to identify the type of scheme that is suitable for them,

This article tells you more about how mutual funds are categorised based on their structure, the types of assets they invest in, and their investment objectives.

Types of mutual funds based on asset class

Mutual funds can be categorised based on the type of asset class they invest in. Under this classification, there are five main types:

Equity mutual funds: These funds primarily invest in stocks. They may be suitable for new investors who wish to invest in the stock market but lack the expertise or time to identify stocks and make trading decisions.

Debt mutual funds: These funds primarily invest in fixed-income securities such as bonds. They may be suitable for investors who seek the potential for relatively steady returns and lower risk to capital as compared with equity mutual funds.

Hybrid mutual funds: These funds invest in a mix of equity and debt securities and are suitable for investors who want a balanced portfolio of stocks and bonds. The equity component can deliver potential capital appreciation in the long-term, while the debt component can potentially generate a steady income.

Solution-oriented funds: Such funds are geared towards specific financial objectives. The Securities Exchange Board of India (SEBI) has specified two solution-oriented funds that AMCs can offer: retirement fund and children’s fund.

Other mutual funds: These funds include sectoral funds, thematic funds, international funds, and commodity funds. For instance, sectoral funds invest in specific sectors, such as technology, healthcare, or energy; international funds invest in overseas markets, while commodity funds invest in commodities.

Types of mutual funds based on structure

Mutual funds can also be classified based on their structure. These are the types of mutual funds based on structure:

Open-ended funds: These funds are the most common type of mutual funds and allow investors to buy and sell units of the fund at any time. The number of units is not fixed, and the fund can issue or redeem units as per the applicable price and the amount of investment.

Close-ended funds: These funds have a fixed number of units, and the fund is only open for a specific period. Once the fund is closed, investors cannot buy or sell units. However, they can be traded on stock exchanges depending on liquidity. Units can be sold or purchased from the secondary market.

Interval funds: These funds are open to investors during certain periods or intervals. During these windows, investors can purchase or redeem units. The rest of the time, the fund is closed for subscriptions or redemptions. As per guidelines, the transaction interval should be for a minimum of two days and there should be at least a 15-day gap between two transaction windows.

Types of mutual funds based on investment objectives

Mutual funds may be actively or passively managed.

Actively managed funds: The fund manager has the flexibility to select stocks or debt securities and craft the portfolio based on their investment objective and strategy. However, they have to adhere to regulatory guidelines on what types of securities they can invest in based on the fund category. The goal of such funds is to potentially outperform the market. These managers actively buy and sell securities based on research, market trends, and economic indicators.

Passively managed funds: Passively managed mutual funds (such as index funds) aim to replicate the performance of a specific market index, such as the Nifty 50. The fund’s portfolio includes the same securities in the same proportion as the benchmark index. The goal is to match the performance of the wider market (subject to a tracking error, which is the difference between the fund’s performance and that of the index).

Mutual funds based on risk

Different mutual fund schemes can have different risk levels. The asset management company that introduces the scheme is required to mention the risk profile (in the form of a risk-o-meter) in all important scheme-related communication, including the Scheme Information Document. Broadly, schemes can fall under the following risk categories:

• Low risk
• Low to moderate risk
• Moderate risk
• Moderately high risk
• High risk
• Very high risk

Generally, mutual funds in the low risk to moderate risk range invest predominantly in fixed-income securities, whereas equity-oriented mutual funds fall under the high or very high risk categories.

Conclusion

Mutual funds offer a convenient and diversified way to invest in the stock market, bond market, or a mix of both. Understanding the different types of mutual funds based on asset class, investment objective, and structure can help investors choose the right mutual fund that aligns with their investment goals, risk appetite, and investment horizon. It's equally crucial to align your goals with the scheme's investment objectives. If you are new to investing or unsure about investing in mutual funds, you may want to consider consulting a financial advisor or doing further research before making any decisions.

FAQs:

Is it safe to invest in mutual funds?
Mutual funds can be considered a relatively stable investment option than stocks. However, the value of mutual fund investments can fluctuate based on market conditions, and there is no guarantee that investors will earn a profit. It is always advisable to seek the help of a financial expert before making any investment decision.

Can mutual fund schemes be redeemed anytime?
Most mutual fund schemes that do not come with a lock-in period can be redeemed at any time. It's important to read the terms and conditions of a mutual fund scheme carefully before investing to understand any restrictions on redemption.

What is the difference between an open-end mutual fund and a closed-end mutual fund?
Open-end mutual funds continuously issue new units to investors and redeem units from investors who wish to sell, whereas closed-end mutual funds issue a fixed number of units that trade on a stock exchange. This means that open-end funds can fluctuate in size as more units are issued or redeemed, while closed-end funds remain a fixed size.

What are the two important things one should consider before investing in mutual funds?
An investor should carefully analyse his/her financial goals and risk-appetite before investing in mutual funds. In order to make a well-informed decision, investors can seek the help of a financial expert before starting their investment journey.

Which type of mutual fund gives highest return?
Generally, equity funds offer higher return potential than funds that invest in debt securities. However, they also come with higher risk.

What is a mutual fund portfolio?
A mutual fund portfolio is a collection of various investments, such as stocks, bonds, and other securities, managed by a professional fund manager. The portfolio aims to diversify risk and achieve specific investment objectives, providing investors with exposure to a broad range of assets through a single investment.