Different Types of Mutual Funds: Mutual Fund Types Based on Asset Class, Structure, Risk & Benefits

Retail investment in mutual funds is growing rapidly in India. As of March 2024, there were 17.8 crore mutual fund accounts, with 91.4 percent belonging to retail investors, according to the Association of Mutual Funds of India (AMFI). Retail investors usually have a ticket size of less than Rs. 2 lakhs.

Mutual funds are a key part of modern investing, providing a straightforward and diverse way to invest in financial markets. However, the many choices can be confusing for beginners. This article aims to simplify things by explaining different types of mutual funds based on asset class, structure, risk profile, and their specific advantages.

Understanding Mutual Funds

Before discussing specific types, let’s establish a foundational understanding of mutual funds and the different types of mutual funds in India. A mutual fund pools money from multiple investors and invests it in a basket of securities, such as stocks, bonds, or a combination of both. This diversification helps spread risk and potentially smooth out market fluctuations. 

An asset management company (AMC) collects money from various individual and institutional investors to buy different mutual funds, such as stocks, debentures, and other assets. Investors are given fund units based on their investment amount and can buy or redeem them only at the current net asset value (NAV). The NAV changes daily, reflecting the performance of the underlying assets. 

Mutual funds are regulated by the Securities and Exchange Board of India (SEBI). One key benefit of different types of mutual funds is that investors can diversify their portfolios with relatively low investment amounts.

Types of Mutual Funds Based on Asset Classes

Mutual funds can be broadly classified based on the primary asset class they invest in:

Equity Funds

These funds primarily invest in company stocks, aiming for capital appreciation through long-term growth. Let’s delve into the various types of equity mutual funds, each catering to different risk appetites and investment horizons.

Market Capitalization-Based Funds:

• Large-Cap Funds: These funds focus on established, blue-chip companies with a proven track record. Due to the stability of large corporations, they are considered less volatile but may offer lower potential returns compared to other equity categories.
• Mid-Cap Funds: These funds invest in companies with promising growth potential, positioned between large and small-cap companies. They offer a balance between risk and reward, with the possibility of higher returns but also greater volatility.
• Small-Cap Funds: Target emerging companies with the potential for high growth and significant risk. These funds are suited for investors with a long-term perspective and a tolerance for market fluctuations.
• Multi-Cap Funds: Enjoy the flexibility to invest across the entire market capitalization spectrum, from large to small caps. This diversification helps manage risk while offering the potential for growth across various company sizes.

Investment Strategy-Based Funds

• Focused Funds: These funds concentrate their holdings in a limited number of companies (typically 20-30) that the fund manager believes have strong growth prospects. This concentrated approach offers the potential for high returns but also carries increased risk.
• Dividend Yield Funds: Prioritize companies with a history of paying regular dividends. This strategy aims to generate consistent income for investors while allowing for capital appreciation in the underlying stocks.

– Tax-Saving Option:

• ELSS (Equity Linked Savings Scheme) Funds: Offer the dual benefit of growth potential and tax savings. These funds invest primarily in equities and come with a 3-year lock-in period. Investments in ELSS qualify for tax deductions under Section 80C of the Income Tax Act.

ALSO READ: WHAT ARE ASSET CLASSES? 

Debt Funds

Invest in fixed-income securities like government, corporate, and money market instruments. These funds generally offer lower risk and more predictable returns than equity funds. Subcategories include:

• Liquid Funds: Invest in highly short-term debt instruments with maturities of up to 91 days. This translates to high liquidity, meaning you can easily access your invested money. They are ideal for parking short-term funds and offer returns that are typically higher than traditional savings accounts.

• Overnight Funds: As the name suggests, these funds invest in securities maturing within a single day. This ultra-short maturity minimizes credit risk, making it a very safe option. However, the returns offered by overnight funds are also lower.
• Ultra Short Duration Funds: Invest in a mix of short-term debt instruments with maturities ranging from 90 to 180 days. These funds offer a slightly higher potential return than liquid funds while maintaining a relatively low risk profile.
• Low Duration Funds: These funds invest in debt instruments with maturities between 6 and 12 months. They offer a balance between liquidity and potential returns, but the credit risk is slightly higher than shorter-duration funds.
• Money Market Funds: These funds invest in money market instruments with maturities of up to one year, maintaining high liquidity. These funds invest in treasury bills, commercial papers, certificates of deposits, and repurchase agreements, offering better interest rates than traditional fixed-income instruments like savings accounts and fixed deposits.
• Dynamic Funds: These funds can adjust their Macaulay duration to maximize returns. Fund managers shift the portfolio’s duration by reallocating between short and long-term debt instruments. As interest rates and debt instrument returns are inversely related, short-term debt instruments are less affected by rising rates, while long-term instruments perform better when rates fall. 
• Credit Risk Funds: Credit Risk Funds aim for high returns by taking significant risks. Previously known as Credit Opportunities Funds, SEBI renamed them in 2017. SEBI mandates that these funds invest 65% of their corpus in AA-rated or lower corporate bonds, with no restrictions on the remaining 35%. These funds lend to low-credit-rated corporations with potentially poor repayment histories in exchange for high interest rates.
• Banking and PSU Funds: Banking and PSU Funds are low-risk due to significant investments in banks and government-owned entities. SEBI requires these funds to invest at least 80% of their corpus in banks, public sector undertakings, public financial institutions, and municipal bonds. The remaining 20% can be invested without restrictions, posing a risk if high-risk corporate entities default.
• Gilt Funds: Gilt Funds invest at least 80% of their corpus in government securities, making them one of the safest debt investments. The remaining 20% can be invested in other assets. Another type of Gilt Fund maintains a Macaulay duration of 10 years while keeping a minimum of 80% of their corpus in government securities, exposing them to interest rate risk in a rising interest rate environment.

YOU MIGHT WANT TO READ: DEBT MUTUAL FUNDS VS DIRECT EQUITY

Hybrid Funds

Hybrid mutual funds offer a compelling option for investors seeking a balance between growth potential and risk management. These funds combine equity (stocks) and debt (bonds) investments within a single portfolio, catering to a wider range of risk tolerances than pure equity or debt funds.

SEBI (Securities and Exchange Board of India) regulations categorize hybrid funds based on the proportion of equity and debt they hold. Here’s a breakdown of some popular subcategories:

• Conservative Hybrid Funds: These funds prioritize stability, with a debt allocation ranging from 75% to 90% of the portfolio. The remaining 10% to 25% is invested in equities, offering growth potential with a managed risk profile.
• Balanced Hybrid Funds: As the name suggests, these funds strive for a balanced approach. They typically invest 40% to 60% in equity and equity-related instruments and a similar proportion in debt instruments. This balanced allocation offers the potential for moderate growth alongside income generation.
• Aggressive Hybrid Funds: Designed for investors comfortable with higher risk, these funds emphasize equity more. They may allocate 65% to 85% of their assets to equity, aiming for significant growth potential with a corresponding increase in risk.
• Multi Asset Allocation Funds: Multi-asset allocation funds take diversification a step further. They invest in a broader range of asset classes beyond equity and debt. This might include real estate, gold, or commodities. These funds aim to reduce overall portfolio risk and capitalize on opportunities across different market segments by spreading investments across various asset classes.
• Arbitrage Funds: Arbitrage funds employ a unique strategy to generate returns. They exploit price discrepancies between similar securities traded on different markets. Arbitrage funds aim to capture the profit from the price difference by simultaneously buying and selling these securities. However, this strategy is complex and requires significant expertise from the fund manager.

Types of Mutual Funds Based on Structure and Management

Mutual funds types are  based on their structure and management style too, such as:

• Open-Ended Funds: Open-ended funds, a frequent recommendation in financial advisory, enable investors to consistently buy or redeem shares based on the daily net asset value (NAV) calculation.
• Closed-Ended Funds: Issue a fixed number of shares at an initial public offering (IPO). These shares are then traded on stock exchanges, and their market price can fluctuate from the NAV.
• Index Funds: Passively track a specific market index, like the Nifty 50, to replicate its performance. This approach offers lower fees compared to actively managed funds.
• Actively Managed Funds: The fund manager actively selects investments based on their analysis and market outlook, aiming to outperform a benchmark index.

Types of Mutual Funds Based on Solutions

• Retirement Mutual Funds: Also known as pension funds, Retirement Mutual Funds are designed for long-term investments to provide regular income during retirement. Investors can receive income until the corpus is depleted or withdrawn. These funds have a lock-in period of 5 years or until retirement age, whichever comes first. They typically invest in lower-risk options like government securities to ensure stability and consistent income for retirees.
• Children’s Mutual Funds: Children’s Mutual Funds are intended for long-term financial planning for a child’s education, marriage, and welfare. These funds have a lock-in period of at least 5 years or until the child reaches adulthood, whichever comes first. They invest in equity and debt securities, allowing investors to choose asset allocation based on risk tolerance.

Other Asset Classes: Some mutual fund types invest in alternative asset classes like real estate or commodities, offering diversification beyond traditional stocks and bonds.

Risk and Return: Understanding the Trade-Off

The level of risk associated with a type of mutual fund is a crucial factor to consider. Generally, higher potential returns come with greater risk. Here’s a simplified breakdown:

• Equity Funds: Carry higher risk due to stock market fluctuations but offer the potential for high capital appreciation.
• Debt Funds are generally considered less risky than equity funds. They offer predictable income streams with lower potential for growth.
• Hybrid Funds: Offer a balance between risk and return depending on the asset allocation strategy.
• Other Asset Classes: These can vary significantly in risk depending on the specific asset class.

Benefits of Mutual Funds: Why Consider Them?

Different mutual fund types offer several advantages for investors, including:

• Diversification: Owning a single share of a mutual fund provides exposure to a basket of securities, mitigating risk compared to investing in individual stocks or bonds.
• Professional Management: Fund managers with expertise actively manage the portfolio, taking the burden of security selection and market analysis off investors.
• Accessibility: Mutual funds allow investors to participate in the financial markets with relatively low investment amounts compared to buying individual securities.
• Liquidity: Open-ended mutual funds offer easy redemption of shares, providing investors with access to their funds when needed (except for lock-in periods in specific schemes).
• Transparency: Mutual funds provide regular disclosures about their holdings and performance, allowing investors to monitor their investments.

Investing doesn’t have to be a mystery. You can unlock a world of financial opportunities by understanding mutual fund types, risks, and benefits. Remember, your ideal fund hinges on your risk tolerance and goals. Consult a financial advisor for personalized guidance on your investment journey.

*Disclaimer Note: The securities quoted, if any, are for illustration only and are not recommendatory. This article is for education purposes only and shall not be considered as recommendation or investment advice by Research & Ranking. We will not be liable for any losses that may occur. Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL, and certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors.

FAQ