A Colourful World of Equity Mutual Funds
11 Nov 2019

A Colourful World of Equity Mutual Funds

Equity mutual funds invest in stocks, and when these underlying shares appreciate, the fund value goes up. Most investors are cautious about investing in stocks either due to fear of market risks or lack of expertise. These funds pool in investments from several investors and are professionally managed. A fund manager selects stocks in which the equity mutual fund invests. The aim is to generate returns for investors.

Let us discuss in detail what equity mutual funds mean. These type of funds have a mandate for a minimum of 65 percent of their assets to be equities or similar instruments.

Types of equity mutual funds

Equity funds are classified based on several parameters. Let us take a look.

Based on market capitalisation

One way of classification is based on the market capitalisation of companies. Here they are:

Large-cap funds: These funds invest at least 80 percent of their assets in large-cap companies. The companies rank among the top 100 in terms of market capitalisation. They are well-established, stable companies with good track records. Hence, large cap mutual funds generate stable returns. They are not as volatile as mid- and small-cap funds. These type of equity mutual funds hold up well in a bear market; however, during bull market phases, they generate relatively modest returns. These funds are suitable for the conservative investor.

Mid-cap funds: The funds invest at least 65 percent of their total assets in mid-cap stocks. These stocks rank 101-250 in terms of market capitalisation. These funds provide higher returns than large-cap funds. However, they are more volatile and are ideal for investors who have a higher risk appetite.

Large and mid-cap funds: These equity mutual funds need to invest at least 35 percent of their assets in large-caps and another 35 percent in mid-caps. So, they offer the best of both, and it means there is potential to generate higher returns. However, the presence of large cap stocks gives such funds stability. These funds are for investors, who want high returns yet, look for stability.

Small-cap funds: These funds invest at least 65 percent of its assets in small-cap stocks. These stocks are ranked 251st onwards in market capitalisation. Small-cap funds have the potential to generate very high returns. However, they come with a large amount of risk. These funds are popular among those who have a very high risk appetite.

Multi cap funds: These equity mutual funds invest at least 65 percent of its assets across large, mid, and small-cap stocks. They are thus, market-cap-agnostic. The fund manager has more flexibility with the investments. A person can invest in mid and small caps when there is a market rally. During a bear market, he or she can shift to large-cap stocks. Multi-cap funds can take advantage of opportunities across the market. Multi cap funds are riskier than large-cap funds. But, they are less risky than mid and small-cap funds. Multi-cap funds are meant for you if you have a moderate risk appetite.

Based on sectors and themes

These funds invest in selected sectors or themes. Sector funds can invest in one particular industry. For example, it can be pharma, technology, BFSI, or FMCG. Thematic funds, on the other hand, concentrate on a specific theme. It could be commodity exposure, emerging companies, or international stocks. Both sector and thematic funds are risky because a particular industry or theme can underperform. However, such funds are diversified as far as market capitalisation is concerned.

Based on the style of management

Equity mutual funds may also differ based on management. Fund managers pick particular stocks so that the fund provides higher returns than the benchmark. These funds are actively managed and charge a fee.

Passive funds, on the other hand, track an index. These are also known as index funds. These funds mimic an index, and the portfolio rebalances so that it aligns with the index. Such funds do not need a fund manager. Hence, these funds have lower expenses.

Based on how they are taxed

Equity Linked Savings Scheme (ELSS) is a type of diversified fund. They invest 80 percent in stocks. Investments in ELSS funds are eligible for deduction u/s 80C for tax savings purpose. The maximum deduction available u/s 80C is up to Rs. 1.5 lakh per annum. All equity-oriented funds are subject to short-term capital gains (@15 percent) and long-term capital gains tax (@10 percent). This depends on the holding period. The capital gains taxation on these funds is lower than other asset classes.

Based on investment strategy

Equity funds can also be classified based on their investment strategy.

Value funds: These equity mutual funds pick stocks which are undervalued. So, these stocks are purchased at a relatively lower price. Since the price is low, more stock can be bought. The idea is to sell the shares when the prices go up. This would help generate returns for the investor.

Growth funds: These funds invest in stocks of companies whose primary objective is capital appreciation. There is usually a high growth potential and good earnings. Such companies reinvest their profits in growth or expansion plans. Some even focus on research and development.

Benefits of equity mutual funds

We will now look at the benefits:

Returns that beat inflation: These funds are linked to the market and historically have beaten inflation. Investors can reap the benefits of positive market cycles.

Professional management: Mutual fund houses appoint expert fund managers to manage these funds. The fund managers select stocks in such a manner to maximise returns to investors.

Diversification: When investing in an equity mutual fund scheme, you get exposure to various stocks. This allows you to have a diversified portfolio with investments starting from Rs. 500. Diversification reduces marker associated risks of your portfolio.

Liquidity: Equity funds except ELSS funds can be redeemed instantly. As investments, they are extremely liquid.

Regular investments: You can regularly invest in equity funds in small amounts through the SIP route. This develops a daily savings habit. Regular investments help build wealth over some time.

Tax benefits: Investments in equity funds for more than one year is subject to long-term capital gains of 10 percent if the capital gains are more than Rs. 1 lakh in a year. Further, ELSS funds are eligible for a tax deduction of up to Rs 1.5 lakhs u/s 80c every year.

Who should invest in equity funds?

Equity funds come with a certain amount of risk as they are linked to the markets. There are different types, for people with varying levels of risk tolerance. Those with a low-risk appetite can invest in large-cap funds. Those with a high-risk appetite can invest in mid- and small-cap funds. They can also choose sector or thematic funds. Investing in equity mutual funds is simple. One needs to select the right fund. Investors do not require specialised knowledge.

Markets may seem volatile over the short term, and an investor should hold on to equity fund investments for at least 5 to 7 years. Over an extended period, market volatility evens out.

Equity funds offer a lot of options. Investors can choose a fund which aligns with their risk appetite. There is something for every investor!

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Mutual Fund investments are subject to market risks, read all scheme related documents carefully before investing.