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
• 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

Investment focus

Consumption funds: Focus on companies that produce consumer-oriented goods and services, such as FMCG, healthcare, and telecom.

Equity funds: Invest across a broad spectrum of industries, including financial services, technology, manufacturing, and more.

Diversification

Consumption funds: Concentrate on a specific theme, offering limited diversification within consumer-driven sectors.

Equity funds: Provide extensive diversification by investing in multiple sectors and market capitalisations.

Risk profile

Consumption funds: Higher risk due to sector-specific concentration and dependency on the performance of the consumption sector.

Traditional equity funds: Relatively lower risk as compared to consumption funds as investments are spread across various industries, mitigating the impact of sector-specific downturns.

Investor suitability

Consumption funds: Better suited for experienced investors who can handle sector-specific volatility and have a higher risk tolerance.

Equity funds: Suitable for both novice and seasoned investors, given their balanced and diversified approach.

Return potential

Consumption funds: Returns are closely tied to the growth of consumer spending and economic trends, with potential for high returns during favourable periods.

Equity funds: Aim for steady long-term growth by capitalising on the performance of a diversified range of companies.

Volatility

Consumption funds: More volatile due to their reliance on a specific sector’s performance.

Equity funds: Relatively less volatile, thanks to broader market exposure.

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.

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.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.