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  Mutual Funds

home > Mutuals Funds > Basics of Mutual Funds > Categories of MFs
 CATEGORIES OF MUTUAL FUNDS

Introduction

 
In terms of ease with which investors can enter and exit funds, mutual funds are broadly divided into two classes:
  • Open-ended funds: Investors can buy and sell the units from the fund, at any point of time.
  • Close-ended funds: These funds raise money from investors only once. Therefore, after the offer period, fresh investments can not be made into the fund. If the fund is listed on a stocks exchange the units can be traded like stocks (E.g., Morgan Stanley Growth Fund). Recently, most of the New Fund Offers of close-ended funds provided liquidity window on a periodic basis such as monthly or weekly. Redemption of units can be made during specified intervals. Therefore, such funds have relatively low liquidity.

There are various classes of mutual funds depending upon the nature of investments. Here are three broad classes from which one can choose to invest, depending upon his risk-return profile.

  • Equity funds
  • Balanced funds
  • Debt funds
 
   
Equity funds
 
These funds invest in equities and equity related instruments. With fluctuating share prices, such funds show volatile performance, even losses. However, short term fluctuations in the market, generally smoothens out in the long term, thereby offering higher returns at relatively lower volatility. At the same time, such funds can yield great capital appreciation as, historically, equities have outperformed all asset classes in the long term. Hence, investment in equity funds should be considered for a period of at least 3-5 years.
   Click here .... to view Equity funds summary 
   
  Fund classification based on capitalisation focus :
 
There are also funds based on capitalisation which invest in companies falling within a certain segment of market capitalization. Based on capitalization, equity funds can be placed on the risk return grid as shown below:
 
bullet Balanced funds
 

Their investment portfolio includes both debt and equity. As a result, on the risk-return ladder, they fall between equity and debt funds. Balanced funds are the ideal mutual funds vehicle for investors who prefer spreading their risk across various instruments. Following are balanced funds classes:

  • Debt-oriented funds
  • Equity-oriented funds
 
   
bullet Debt Funds
 

They invest only in debt instruments, and are a good option for investors averse to idea of taking risk associated with equities. Therefore, they invest exclusively in fixed-income instruments like bonds, debentures, Government of India securities; and money market instruments such as certificates of deposit (CD), commercial paper (CP) and call money. Put your money into any of these debt funds depending on your investment horizon and needs.

  • MIPs
  • Arbitrage Funds
  • FMPs
  • Arbitrage Funds
  • Income Funds
  • Floating rate funds
  • Gilt funds
  • Liquid funds
   Click here .... to view Debt funds summary 
   
bullet Risk-return grid
 
 

ST : Short term ; LT : Long term.
Notes:

    Arbitrage funds here include funds which do not indulge in shorting (selling futures without holding the stock) and do not have naked equity positions. They can have upto 50% (as per previous SEBI regulation) or 80% (as per latest SEBI regulation) allocation to equity and equity related instruments.
    The risk-return profile of FMPs depend upon prevailing interest rate scenario, duration of the scheme and outlook on interest rates.
bullet
Innovative funds
  Fund of funds
 
A fund of funds is a mutual fund scheme that invests primarily in other schemes of the same mutual fund or other mutual funds. Hence, it is a step ahead of mutual fund in the sense that while a mutual fund keeps a track of the stocks it invests, a fund of fund keeps track of the mutual funds it invests and hence manages the portfolio on behalf of investors. Such funds are treated as a debt-oriented fund for tax purposes.
  Advantages
  1. Convenience
 
  • Investors switch between different funds at different times, and dynamically manage their portfolio in an endeavour to achieve high risk-adjusted returns. This task of managing the mutual funds portfolio is done on their behalf by fund of funds.
  • Instead of having different account statements for different funds, investing in a fund of fund offers the convenience of having a single consolidated account statement, while still maintaining a diversified portfolio across various schemes.
  2. Flexibility
 
  • Investors can spread their money across different strategies/managers.
  • An investor may not be able to sell off when markets fall in the direct stock market. A fund of fund can easily switch from one fund to another.
  3. Cost factor
 
  • For an investor, who actively manages his portfolio, cost of execution and tax impact on short term switches could be a constraint. In such a case, investment in a fund of fund could prove to be an efficient route
  Disadvantages
 

1. Fee structure

 
  • Expense fees on fund of funds are typically higher than those on regular funds because investors have to bear expenses for the main fund of fund and other funds it invests into.
  2. Stock-wise portfolio tracking
 
  • Since a fund of funds buys many different funds which further invest in many different stocks, it is possible for the fund of funds to own the same stock through several different funds. Thus, it may be difficult for an individual investor to keep a track of the overall stock holdings.
  Risk-return profile
 
Its position in the risk-return grid depends on its allocation to equity and debts funds.
   
bullet Derivative funds
 
They invest in the derivative market which limit the downside risk by selecting hedging approach and also offer additional return through shorting procedure.
  Advantages
  1: Limit the downside risk
 
  • Derivatives are generally used for hedging purpose so that they can limit the downside risk of equities. Hence this fund will be suitable in a falling market.
  2: Higher potential in generating returns
 
  • It can offer higher return through short or long positions. But this involves high risk.
  Disadvantages
 
  • The investor has the possibility of loosing his money if the fund takes unhedged positions.
  Risk-return profile
 
If the fund follows only hedging procedure then it can be termed as low risk - low return category. But if it takes short positions or unhedged positions then it can fall under high-risk, high-return category.
   
bullet Internationally diversified funds
 
They invest in equities and equity related instruments of companies listed overseas.
  Advantages
 
  • Geographical diversification to investors
  • It provides additional diversification and flexibility to overcome country-specific factors
  Disadvantages
 
  • It can lead to volatility if it is exposed to expensive markets like Brazil or Russia
  Risk-return profile
 
It depends on the foreign market it is exposed to.
   
bullet Capital protected funds (CPFs)
  These funds intend to offer reasonable return while protecting the capital.
 
Trying to understand capital protection strategies using financial jargons is like cracking a puzzle. But these strategies are based on one simple formula which can be adopted by anyone. Let us consider a case where one wants to invest Rs. 100 for a period of 3 years. Assuming debt paper return of 8% p.a., one can invest Rs. 80 in such paper for three years. This will grow to Rs. 100.77 at the end of 3 years. He can use the remaining Rs. 20 to invest in other risky avenues which has the potential of generating higher returns. If the risky avenues yield favorable returns, he will receive Rs. 100 plus gains on Rs. 20 invested in risky avenues. On the other hand if he loses his entire Rs. 20, he still manages to secure Rs. 100 at the end of three years. Thus, initial investment once made in debt and equity (in the report risk-free portion will be referred as debt and risky avenue will be assumed as equity) is not changed over the life time of the fund and it remains static. Therefore, it is known as Static Asset Allocation.
In one more type of capital protection strategy, the allocation to debt and equity is revised and changed periodically (daily, weekly, fortnightly or monthly). It is known as dynamic asset allocation.
Multiplier: It is an implied leverage which is applied to the portfolio, which decides the risk that a portfolio can be exposed to. It generally varies from 2 to 5. Higher the multiplier, higher will be the portfolio's equity exposure in rising markets.
 
 
   
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