Mutual Funds – An Introduction

The idea of saving money and investing it is ingrained in the Indian society. As children, we all remember going to a nationalized bank with our parents/ grandparents for renewal of fixed deposits or withdrawing the interest earned. As years went by, the avenues of investment underwent a change. Investments such as equity, real estate and mutual funds soon became household terms.

What are Mutual Funds?

First and foremost let’s explain mutual funds in layman’s terms –

Imagine there is a group of 10 people (investors) that you may or may not know who all have to invest their savings. Fortunately, all of you have the same objective of say, long-term wealth creation by investing in the stock market. You find a guy who is an expert at investing the money based on your objective. You each transfer the money to a common pool. The expert starts investing this money and any gains/losses accrued on the investments are split pro rata amongst the group based on the amount you put in.

Mutual funds are a mechanism where people can pool in their money, which is then invested based on a stated objective. Moreover, they are centrally regulated by a government-attached body in order to eliminate any fraud related risks. They are also extremely tax efficient and are managed by the biggest names in the financial services industry.

In India, there is a mutual fund for almost every investing objective you may have. Some of the objectives are:

  • Safe Investing as an alternative to fixed deposits (Debt Mutual Funds)
  • Saving Taxes (ELSS Mutual funds)
  • Investing only in big well-established companies (Large Cap Mutual fund)
  • Invest in the US, European, Chinese Stock Markets (International Feeder Mutual Funds)

Types of Mutual Funds

There are many terms that one hears when looking to invest in Mutual Funds. These may seem like the best ways to describe certain funds, but they are nothing but jargon to many. To help you decode these terms, here is an overview of the types of Mutual Funds available. We can categorize mutual funds based on the following classifications:

Investment Objective based classification

Based on the investment objective of the scheme, Mutual Fund schemes can be classified as

  • Growth schemes

    These schemes work with an objective of generating wealth in the long-term. Apt for goal based investments like marriage, retirement or children’s education.

  • Income Schemes

    These schemes work with an objective of generating regular income without taking too many risks with the capital. Such schemes usually invest in debentures, bonds and other fixed-income options.

  • Liquid schemes

    These schemes work with an objective of improving regular income/ generating wealth without compromising the liquidity of the funds. These are typically short-term investments made in treasury bills, commercial papers and other similar instruments.

  • Tax-Saving Schemes (ELSS)

    These schemes work with an objective of allowing investors to benefit from the tax deduction offered by the Government under Section 80C of the Income Tax Act, 1961. The investments are made in equities and have an element of higher risk associated with them.

  • Capital Protection Schemes

    These schemes work with an objective of ensuring maximum safety of the capital invested. The funds are invested in a balanced manner between equity and debt to ensure that at any stage, the capital is not at risk.

  • Fixed Maturity Plans

    These schemes work with an objective of generating steady returns over a fixed period of time and safeguard the investors from market volatility. The investments are made in money market and debt instruments.

  • Pension Schemes

    These schemes work with an objective of providing regular income after retirement. The investment is made in equities and debt instruments to ensure that the corpus keeps growing while providing a regular income.

Structure-based classification

Mutual fund schemes can also be classified based on the structure – the way investments are accepted from investors.

  • Open-ended schemes

    These schemes allow buying and selling of units from the fund house at prevailing market rate (Net Asset Value or NAV) on all trading days. Also, there is no restriction on the number of shares that the fund can issue. These are the most common type of schemes available.

  • Close-ended schemes

    These schemes allow buying of units from the fund house only during the New Fund Offer (NFO) period and have a pre-specified maturity period.

  • Interval schemes

    These schemes are a combination of open and close-ended schemes. Units of such schemes purchased or redeemed at time intervals pre-determined by the fund house.

Asset Class based classification

  • Equity schemes – These schemes invest in equity or stocks or shares. There are many variants available under these schemes Blue Chip schemes, Small Cap schemes and so on. As compared to other schemes, they carry greater risk.

  • Debt schemes

    These schemes invest in debt instruments like government securities, company debentures and so on. Moreover, they offer fixed returns and are therefore considered safer than the equity schemes.

  • Money market schemes

    These schemes invest in treasury bills, commercial papers, etc. They endeavour to offer quick liquidity, capital preservation and average income.

  • Hybrid or Balanced schemes

    These schemes offer varying proportions of equity and debt investments to cater to different preferences of investors. Depending on the mix, the returns and risks are managed.

Specialization based classification

  • Sector schemes

    These schemes focus on a particular sector as defined in the investment objective of the scheme. For  IT schemes, infrastructure schemes, etc.

  • Index schemes

    These schemes invest in shares that mirror the performance of a certain index like a BSE or NSE, etc.

  • International schemes

    These schemes invest in global markets by adding international exposure to the investor’s portfolio.

  • Fund of funds

    These funds invest in schemes of other mutual funds. These can be equity, debt or hybrid as specified in the investment objective of the fund.

  • Exchange traded funds

    These funds are a mix of open and close-ended funds and are traded on the stock exchange.

Apart from the ones listed above, there are emerging market funds, real estate funds, commodity-focused stock funds, market neutral funds, inverse funds, gift funds and many more.

Risk-based classification

 based on the risk to the invested capital we can categorize mutual fund schemes such as:

  • High risk

    These schemes invest in securities like equities that have a higher element of risk associated with them. They endeavour to provide an opportunity to earn high returns and generate wealth.

  • Low risk

    These schemes invest in debt market instruments like government securities which have a minimal risk to the invested capital. They strive to protect the capital and offer relatively lower returns.

  • Medium risk

    These schemes try to find the right balance between the high and low-risk approaches and endeavour to offer good returns with an average amount of calculated risk.

The Indian Investing Landscape

The Indian Mutual fund industry has grown leaps and bounds in recent years. Here are some figures shared by AMFI:

  • The AUM of the Indian MF Industry has grown from ₹ 5.05 trillion as on 31st March 2008 to ₹22.60 trillion as on 31st May 2018, about four and a half fold increase in a span of 10 years!!
  • The MF Industry’s AUM has grown from ₹7.01 trillion as of 31st March 2013 to ₹22.60 trillion as of 31st May 2018, more than three-fold increase in a span of 5 years !!

In India, the mutual fund ecosystem consists of players:

  • The Mutual Fund House or the AMC [HDFC MF, ICICI MF, etc.]
  • Intermediaries
    • Banks [HDFC, ICICI, etc.]
    • Distributors [NJ India Invest Pvt. Ltd, IIFL Wealth Management, etc.]
    • Stock Brokers [Angel Broking, Sharekhan, etc.]
    • Financial Advisory Companies [Bajaj Capital Limited, B.T.S. Investment Advisors Limited, etc.]
  • Independent Financial Advisors (IFAs)
  • Online Portals for:
    • Buying / Selling [Moneyjar, Karvy, CAMs, etc.]
    • Investment Advice [Moneyjar, Investment Yogi, etc.]
    • Research Platforms [Moneycontrol, Value Research, etc.]

One thought on “Mutual Funds – An Introduction

Leave a Reply