Understanding the difference between consumption funds and traditional equity funds

Mutual funds in the Indian investment landscape have evolved into a diverse universe, offering various options to suit different investor needs. Among these, consumption funds and traditional equity funds stand out as popular choices for investors. While both are equity-based, they differ significantly in their objectives, strategies, and risk profiles. While consumption funds focus on consumer-driven sectors, equity funds provide broad-based diversification.

In this article, we will understand the differences between consumption funds and traditional equity funds, how both work and their potential benefits. We will also discuss aligning your investments with your financial goals and selecting the option that fits your portfolio.

Table of contents:

• What is a consumption fund?
• What is an equity fund?
• Key differences between consumption funds and equity funds
• Benefits of investing in a consumption fund
• Benefits of investing in a traditional equity fund
• Tax implications of consumption funds vs traditional equity funds
• Which fund is suitable for you?

What is a consumption fund?

A consumption fund is a thematic equity fund that focuses on investing in companies that provide consumer-driven products and services. These companies span a broad range of industries, catering to the everyday needs and wants of people. Some of the industries that consumption funds invest in are FMCG, realty, automobiles, telecom etc.

By investing in a consumption fund, you are essentially betting on consumer spending, which grows alongside economic development and population increase. The constant demand for consumer goods makes these funds a suitable option for steady growth potential over time as the overall economy expands.

Therefore, consumption funds thrive on the idea that, irrespective of economic cycles, people continue to purchase essential goods and services, offering a degree of relative stability in a dynamic market.

What is an equity fund?

An equity fund is a diversified mutual fund that invests in shares of companies across various sectors. Its primary goal is long-term capital growth, capitalising on the growth potential of equities to generate returns for investors over a long horizon.

Types of equity funds

Some of the common types of equity funds are:

• Large-cap funds: Invest in blue-chip companies with stable return potential and relatively lower risk.
• Mid-cap and small-cap funds: Focus on growth-oriented companies, offering higher return potential but at greater risk.
• Sectoral funds: Target specific sectors, including consumption funds.

Key differences between consumption funds and equity funds

Benefits of investing in a consumption fund

Sector-specific growth

• Provides exposure to high-growth industries like FMCG and telecom.
• Offers the opportunity to potentially benefit from rising consumer spending and urbanisation.

Direct impact of economic growth

• Increased GDP and per capita income drive consumer demand, boosting fund performance.

Long-term resilience

• Historically, consumption stocks have shown strong performance during economic upturns.

Benefits of investing in a traditional equity fund

Diversification

• Balancing out risk by spreading investments across multiple sectors and market capitalisations.

Flexibility

• Allows investors to choose from large-cap, mid-cap, or multi-cap funds based on their risk tolerance.

Professional management

• Portfolios are actively managed by experts who respond to market trends.

Accessibility

• Suitable for both novice and experienced investors, catering to diverse financial goals.

Tax implications of consumption funds vs traditional equity funds

Although consumption funds follow a sector or theme-based approach and traditional equity funds follow broad market strategies, the tax treatment remains the same. All funds that invest 65% or more in equities are treated as equity-oriented funds for taxation purposes. The tax rate is as follows:

• Short-term capital gains (STCG): If units are sold within 12 months of acquisition, the gains are treated as short-term and taxed at 20%.
• Long-term capital gains (LTCG): If units are held for more than 12 months, gains qualify as long-term. LTCG of up to ₹1.25 lakh are tax-exempt and thereon the tax rate is 12.5%.

Which fund is suitable for you?

Choose a consumption fund if:

• You are a seasoned investor familiar with thematic funds.
• You believe in the growth potential of consumer-driven sectors.
• You are comfortable with higher volatility for potentially higher returns.

Choose a traditional equity fund if:

• You prefer a diversified portfolio with balanced risk.
• You aim for long-term wealth creation.

A balanced approach: Investing in both

The discussion about consumption funds and traditional equity funds is not necessarily a question of one or the other. Investors may also consider combining both in their portfolio. While diversified equity funds, debt funds and other categories can form the bulk of such a portfolio, sectoral or thematic funds can provide the opportunity to tap into an emerging sector that has the potential to outperform the broader market. This can result in a more optimum risk-return balance.

Thus, such a dual approach can help investors potentially harness sector-specific opportunities without over-concentrating risk.

Conclusion

Both consumption funds and traditional equity funds have unique strengths and cater to different investor profiles. By understanding the nuances of equity vs consumption funds, you can make informed decisions aligned to your unique objectives and risk appetite, and embark on your investment journey with confidence.

FAQs:

Is a consumption fund a good investment?

Consumption funds may be suitable for seasoned investors who can handle sector-specific risks. These funds can offer a reasonable return potential if the consumption theme performs well but are associated with a higher level of risk compared to diversified equity funds.

Which type of equity fund is suitable?

The suitability depends on your risk appetite. Choose large-cap funds for relative stability and modest growth potential. Opt for mid-cap or small-cap funds for higher growth potential if you are willing to accept a much higher level of short to mid-term volatility. Multi-cap funds offer a balance of growth potential and relative stability.

What is the main difference between consumption funds and traditional equity funds?

Consumption funds invest mainly in companies or sectors linked to consumer spending such as retail, FMCG, autos, or discretionary goods, while traditional equity funds invest across sectors. Consumption funds are sector or theme-focused, making them more concentrated and sensitive to consumer demand trends compared to diversified categories.

Are consumption funds riskier than traditional equity funds?

Consumption funds may carry higher risk because they focus on a single theme. Their performance depends on consumer-driven sectors, making them more sensitive to economic cycles. Traditional equity funds diversify across industries, which may reduce concentration risk. Investors should assess risk appetite and time horizon before considering thematic exposure within a portfolio.

Can beginners invest in consumption funds?

Beginners may invest in consumption funds, but these require understanding of sectoral cycles and concentration risk. They also require a higher tolerance for volatility compared to more diversified categories. New investors often begin with broader equity funds to build familiarity. Those considering consumption funds may evaluate suitability, long term goals, and how much thematic exposure fits within their overall strategy.

How do consumption funds perform during inflation?

During inflation, consumption funds may experience mixed performance across sectors. Essential-goods companies may show relatively steady demand, while discretionary spending may weaken. Outcomes depend on pricing power, input costs, and broader economic conditions. Since returns remain market-linked, investors assess inflation trends and sector resilience rather than assuming uniform performance across consumption-focused businesses.

Should I invest in both consumption and traditional equity funds?

Investors may use both consumption and traditional equity funds to diversify across broad markets and specific themes. Traditional equity funds provide wider exposure, while consumption funds offer focused sector participation. Allocation depends on goals, risk appetite, and review frequency. Thematic/sectoral exposure is usually kept limited to avoid excessive portfolio concentration.

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