20 types of mutual funds in India that you need to know about - Part 1
In this 4-part article series, we discuss the 20 main types of mutual funds available in India and whether you should be investing in them. The main classification of mutual funds is by asset class ( i.e. what assets they are investing in) and in part 1 of the series we discuss the different types of equity mutual funds.
Funds that invest in shares of different companies and other equity related instruments such as derivatives, warrants etc.. Equity fund can be further classified according to market cap, active/passive, by sectors/themes and by geography. Also tax treatment has created another class of equity funds called ELSS (Equity-linked Savings Scheme).
Equity mutual funds - an introduction
You can also read about the 7 different types of equity mutual funds in India in this infographic. Click for an enlarged version.
1. Large-Cap funds:What they invest in: Invest in shares of the largest companies on the stock exchange. Usually the top 50 stocks by market cap (shares outstanding*price) are considered large cap.
Should you be investing in them: Equities are expected to give high (double-digit) returns but can show significant ups and downs in any single year. Hence they are recommended for investors who can stay invested for an extended period of time (5+ years) and have the risk appetite to stay invested through the interim ups and downs. Among all equity funds, large cap funds are considered to be among the safest and suitable for beginner investors in equity mutual funds because (1) they are diversified so risk is spread across different industries and (2) they invest in large companies with established businesses.
2. Mid and Small-cap funds:
What they invest in: Invest in shares of smaller companies listed on the stock exchange. Usually the next 200 stocks after large cap are considered as mid cap and the next 500 stocks are considered as small cap.
Read: The different types of mutual funds in equities by capitalization for more on how large, mid and small cap funds are related to each other
3. Multi cap/Flexi cap funds:What they invest in: Invest in shares from different cap segments. Exact proportion of investment in large cap vs mid cap vs small cap stocks in different mid cap funds should be looked up in their respective factsheets.
Should you be investing in them: Like large and small and mid cap equity funds, these funds are also recommended for investors who have high risk appetite and can stay invested for 5+ years. Risk and expected returns lie between that of large cap and mid and small cap funds, depending on the market cap composition as mentioned in the fact sheet. While comparing multi-cap funds, it is extremely investors should not look at the returns alone but see returns in context of the cap composition that they hold.
4. Index Funds:What they invest in: Usually Index funds are mutual funds which passively track a benchmark index unlike active mutual funds which try to beat a benchmark by applying a strategy (Source: Investopedia). Index funds can exist in any asset class, however in India Index mutual funds are only found in the equities tracking either the large cap or mid and small cap index . You can find the exact benchmark that a particular fund is tracking by looking at its fact sheet.
Should you be investing in them: Since index funds are just passive versions of the largecap, multi cap and mid and small cap funds discussed earlier, they are also suitable for a similar kind of investor profile: high risk appetite and investment horizon of 5+ years. The big advantage of going with index funds is that they have lower costs. So if you do not believe that active mangers will outperform their benchmark (most US studies show this, though data is less clear for India), then you can opt for this low cost alternative to gain exposure to equities.
5. Sector/Thematic Funds:
What the invest in: Invest only in shares from a particular sector or theme. Some common sectors for which mutual funds are available in India include: Financial services, FMCG, Energy, Healthcare etc. Similarly common themes include PSU/MNC etc.
Should you be investing in them: As sector/thematic funds have more concentrated exposure, they are suited for investors who are bullish on that sector/theme. However sector performance is also linked to economic cycle. For instance sectors such as FMCG, Healthcare and Utilities are considered defensive because their sales react less to what is happening in the economy. On the other hand there are cyclical sectors such as Auto, Banking etc which are very tightly linked to economic conditions. So investors can also hold a bunch of sector funds (defensive or cyclical) to express their view on the economy in general rather than just a particular sector. Having said that in general these fund are not that suitable for an average retail investor who wants to get an exposure to equities. Such investors are better of with the diversified funds that we discussed earlier.
6. International Funds
What they invest in: Invest in equities of other countries. Because the fund manager has to buy the equities of these other countries in their local currency, they need to convert INR to local currency. Hence these funds are also effectively holding the foreign currency vs. INR and will do well if the foreign currency strengthen/INR weakens.
Should you be investing in them: The requirements for buying equities anywhere remains the same: high risk appetite and long time horizon. However investors need to beware of the high expense ratios (annual % costs) of holding a mutual fund. As such investors should only look at international funds, if they already have a sufficient amount already invested in domestic equity funds. Also in such case it makes sense to opt for globally diversified international funds rather than those pertaining to a specific country unless and untill the investor is suitably knowledgeable about individual markets.
What they invest in: ELSS funds are a special kind of equity fund which enjoy tax exemption under Section 80C of the Income Tax Act. Any investment in ELSS funds is tax-exempt up to a limit of 1.5 lakhs (limit is subject to other 80C investments that you already have). Further gains and maturity amount are also tax free. However unlike other equity funds, ELSS funds have a lock-in period of 3 years during which investors cannot withdraw their money. From an investment point of view, ELSS funds are also multi-cap equity funds with a larger bias towards large-cap equities.
7. ELSS (Equity-linked Savings Scheme)
Read: How do ELSS funds compare with other equity funds
Should you be investing in them: You should invest in ELSS funds if you would consider investing in multicap/largecap funds. Many investors are often encouraged to invest in ELSS funds to "save taxes". However investors should remember that they have both Equity options (ELSS) and fixed return options(such as PPF) when it comes to saving taxes under 80C. And they should make the choice between them depending on the overall asset allocation they decide. ELSS/Equities have the promise of higher returns but also come with higher risk. Further even though the lock-in of ELSS funds is just 3 years as we discuss above, investors should be prepared to remain invested for at least 5 years to expect good returns.
Read: Answer these 3 questions to know whether you should be investing in ELSS