A Comprehensive Guide to Different Types and Categories of Mutual Funds in India

Imagine entering a vast restaurant with an overwhelming menu, leaving you unsure where to start. Investing in Mutual Funds feels a bit like that, but instead of a menu, we have lots of categories and types of Mutual Funds, each serving a different purpose to choose from.

In this article, we’ll explore a crucial concept – how Mutual Funds are grouped, similar to organizing dishes into categories on a menu. So, let’s dive into the world of Mutual Fund groups and make it as easy to understand as picking your favorite dish from a well-organized menu.

Table Of Contents

1.) Types of Mutual Funds in India – Anectodes From Food
2.) Different Categories of Mutual Funds in India
3.) Mutual Fund Types in India – Equity Fund
4.) Mutual Fund Types in India – Debt Funds
5.) Mutual Fund Types in India – Hybrid Funds
6.) Mutual Fund Types in India – Solution-oriented categories
7.) Mutual Fund Types in India – Other Funds
8.) Conclusion

First of all, why is this classification of Mutual Funds required?

Before delving into the categories of Mutual Funds, let’s first explore why they are necessary. To grasp this concept more effectively, let’s draw a comparison with something we all cherish—FOOD.

Think of Mutual Funds as a big market with many food stalls, kind of like a fun street food festival. Each stall is like a different type of Mutual Fund, and the people investing in it are like food lovers checking out all the different choices.

In this busy market, investors are like food enthusiasts, each with their likes and dislikes. Just as some folks enjoy spicy street food and others like simpler snacks, investors have different money goals, risk levels, and plans for how long they want to invest.

1.) Types of Mutual Funds in India – Anectodes From Food

Food Stalls (Mutual Funds): The stalls in the market are like different types of Mutual Funds – some are for stocks (Equity Funds), some for safer options (Debt Funds), and others are a mix of both (Hybrid Funds).

Food Preferences (Investor Profiles): Like people who have favorite foods, investors have different money goals. Some want to take more risk for higher returns (like enjoying spicy food and going for Equity Funds), while others prefer safer choices (similar to enjoying basic snacks like Debt Funds).

Unique Tastes (Risk Tolerance and Time Plans): Just like some people can handle spicy food, some investors are okay with the ups and downs of the stock market. Others like things stable. Time plans, or how long they plan to invest, also matter – some want quick results, while others are in it for the long haul.

Financial Choices (Options for Every Need): The whole market is like the world of Mutual Funds, offering a bunch of choices to fit what each investor wants. Whether someone likes the excitement of stocks (Equity Funds) or the comfort of safer options (Debt Funds), there’s something for everyone.

Similar to someone exploring a food festival to find what they like, we, as retail investors, need to explore Mutual Funds to meet our money goals. This comparison shows how different types of Mutual Funds match up with what we want, kind of like the variety you find in a busy food market.

This idea of having so many choices is relatively new in India. Before 1991, there weren’t as many options as possible because the market and economy were more controlled. But after that, things changed, and now many more choices have transformed the way the country works.

As we are discussing how and why the classification matters, it may also be worth checking out earlier articles about the evolution of our Mutual Funds in India and how SEBI is safeguarding Mutual Fund investors

2.) Different Categories of Mutual Funds in India

There are different categories of Mutual Funds. The following image provides a full universe of the types of Mutual Funds available in India. We have 37 in total, 11 in Equity, 16 in Debt,6 in Hybrid, and 2 in solution-oriented

3.) Mutual Fund Types in India – Equity Fund Categories

To build a successful investment collection, it’s important to understand equity investing.

Equity in Mutual Funds is like adding spice to your investment dish. It offers the potential for higher returns compared to bonds, bringing excitement and flavor. Just like how spices develop taste over time, equity investments in Happy Investing! are known for long-term growth despite short-term volatility.

Additionally, equity serves as an inflation hedge, historically outpacing rising costs, ensuring your investment retains its purchasing power over time.

What are they?

Let’s now delve into the intricacies of equity funds with a different analogy that we all love. FOOD again.

Large-Cap Funds (Classic Renowned Restaurants)

Imagine large-cap funds as those popular restaurants that have been around for a while, and everyone loves. These restaurants are like the big players in the food scene, known for their delicious and consistent dishes. Similarly, large-cap funds invest in big and stable companies that have a strong history. Just like(we people trust and enjoy our favorite restaurant for its reliable flavors, investors trust large-cap funds for a stable and reliable investment experience.

Mid-Cap Funds (Street Food Stalls):

Mid-cap funds are akin to the vibrant street food stalls you find in Indian markets. These stalls may not be as widely known as restaurants (large caps), but they offer unique and exciting flavors. Similarly, mid-cap funds invest in companies that are not as large as those in large-cap funds but have growth potential.

Small-Cap Funds (Local Delicacies):

Small-cap funds are like the lesser-known local delicacies. Just as these dishes might be hidden gems in regional cuisine, small-cap funds invest in smaller companies with significant growth potential, though they come with higher risk, similar to exploring local delights.

Sectoral Funds (Regional Cuisine Restaurants):

Sectoral funds focus on specific sectors, much like restaurants that specialize in regional cuisine. Investing in these funds is like immersing yourself in the unique flavors of a particular industry, such as technology or healthcare.

Dividend Yield Funds (Family Feast):

Think of dividend yield funds as a reliable snack bar that regularly serves you your favorite treats. Similar to how a snack bar ensures a steady supply of tasty snacks, these funds invest in stocks that regularly pay out dividends, ensuring investors a continuous stream of income, much like enjoying your favorite snacks regularly.

Value Funds (Discount Markets):

Value funds are like exploring local markets where you can find hidden discounts. These funds aim to discover undervalued stocks with the potential to grow, similar to finding great deals in bustling markets. However, these value/contra funds aren’t the fundamental options for beginners. They might be more suitable at a later stage in their investment journey, once they have established a foundation with basic investments.

Mixed Categories:

Think of these funds like the food streets you find everywhere. Just like food streets have all sorts of restaurants and cuisines, flexi-cap, large- and mid-cap, and multi-cap funds include a mix of stocks from different categories. SEBI, which is like the supervisor, makes sure that the amounts invested in each type of fund are controlled.

ELSS:

Equity-linked saving schemes (ELSS) fall under flexicap but the only exception is that they have a three-year dynamic lock-in period, which means you can’t take your money out for three years. But they do come with tax benefits and can be claimed for up to Rs.1,50,000 a year.

Index Funds:

Considering index funds can be a wise choice due to their consistent performance. However, it’s important to note that many actively managed funds are generally considered superior to index funds. The distinction lies in how these funds are managed. We shall discuss more on this further when we discuss Index funds and ETFs later in the article.

4.) Mutual Fund Types in India – Debt Funds

Think of investing as a tightrope walk where excitement comes from the risky venture of equity funds, akin to walking the tightrope without a net. However, to ensure safety, there’s a crucial element – the safety net represented by debt instruments.

The primary goal of investing is to safeguard against downturns, and debt funds play the crucial role of providing stability and protection.

Equity funds offer the excitement of high returns through capital appreciation, while debt funds serve as a safeguard, protecting capital during market turbulence. This balanced strategy, much like walking a tightrope with a safety net, underscores the significance of diversifying investments for a blend of thrill and security in the unpredictable financial world.

The categories:

Courtesy: www.livemint.com

i.) Overnight Fund:

The first type is an overnight fund, which invests in debt securities like treasury bills and other technical instruments that we won’t delve into here. What’s important to grasp is that the average maturity of the bonds in this overnight fund is just one day. This means that all the bonds in the fund will mature or pay back the principal, along with interest, on the very next day.

ii.) Liquid Fund:

The next category is a liquid fund, containing bonds that usually mature in three months. It may include bonds issued several years ago that now have just three months left until maturity. The purpose of this category is to safeguard your principal amount while enabling you to aim for the sum needed within the next three months. It’s commonly used to temporarily park funds required in the next two to four months for goals like making a home down payment, covering education expenses, or funding a vacation. The strategy here is to avoid taking risks with this money and opt for investments with low risk.

iii.) Ultra-Short Duration Fund:

Ultra-short-duration funds are ideal for an investment horizon of three to six months. Here’s a scenario to consider: When interest rates rise, bond prices tend to fall. Imagine you’re a fund manager holding bonds that yield a 6 percent interest. However, due to an increase in policy rates, new bonds are now being issued at 8 percent- that means the new demand is set at 8% bond. So, the demand for the 6% bonds is now low. This is a strategy many fund managers adopt, leading to increased sales in the market. When there’s an excess supply of bonds, prices typically decrease. Therefore, the low bonds are the least chosen.

vi.) Low-Duration Fund:

Low-Duration Fund is very suitable for monetary needs about six months to a year away, aiming to match the holding period with the bond portfolio. So, if you have a target for some investment within the next year, you can easily go for this type of fund.

v.) Money Market Fund:

Money Market Funds are best for those investors who have money needs within the next year. The terms and conditions apply exactly as the above.

vi.) Short-Duration Fund:

This type of fund is similar to a money market fund with the exception of the time period. It basically needs between one and three years to cover your money needs.

vii.) Medium-Duration Fund:

As exact as the short-duration fund, this fund serves your financial goals for the next three to four years in the future.

viii.) Medium-to-Long Duration Fund:

In this kind of fund, the target to build a corpus is four to seven years away.

ix.) Long Duration Fund:

As you can guess from the name, long-duration funds are suitable for a holding period of more than seven years.

x.) Dynamic Bond Fund:

A dynamic bond fund gives the fund manager the flexibility to hold bonds with different maturity dates, spanning various durations. Typically, this type of fund is categorized as having a moderate risk level on the Risk-o-Meter. However, it’s generally not recommended for new bond fund investors because there is a higher level of risk associated with the decisions made by the fund manager in this case.

xi.) Corporate Bond Fund:

Investors often find corporate bond funds and credit risk funds appealing due to their potential for high returns. In 2015, credit risk funds outperformed other Mutual Fund categories and asset classes. To understand these funds, it’s crucial to grasp credit risk—the chance that borrowers won’t repay interest and principal. Unlike the government, which borrows at low rates due to zero credit risk, high-risk sectors like real estate offer high-interest bonds. Debt funds focusing on non-government bonds are called corporate bond funds, meant for investors seeking higher returns. These funds are rated low to moderate on the Risk-o-Meter.

xii.) Credit Risk Fund:

Credit risk funds invest in bonds with a credit rating of AA and below, as assessed by credit rating agencies. These ratings, ranging from triple-A (low risk) to D (high risk or junk bonds), help investors evaluate the likelihood of timely interest and principal repayment. Some fund managers seeking high-risk, high-return opportunities favor bonds with lower credit ratings. SEBI renamed the category from “credit opportunities” to “credit risk” to convey to retail investors that the potential for higher returns comes with significantly increased risk. Simply put, it’s advisable to leave this category for those who fully understand debt funds and are comfortable taking risks in the safer part of their portfolio.

xiii) Gilt Fund:

Gilt funds exclusively invest in government securities from both the central and state governments. While they pose interest rate risk due to longer maturity, they do not carry credit risk. Although holding them in the short term can be risky, gilt funds generally offer good returns over an extended holding period. Funds with a holding period of ten years or more are known as gilt ten-year constant duration.

xiv.) Gilt-ten-year constant Duration:

So, what is this type of fund? And how is it different from the previous one? A gilt-ten-year fund invests in government securities like the classic Gilt Fund, but only for ten years.

xv.) Banking and PSU Fund:

The banking and public sector undertaking (PSU) fund focuses on investing in bond papers issued by banks, public sector units, and public financial institutions. With significantly lower credit risk from these entities, the main risk factor is related to changes in interest rates. The combination of low credit risk and manageable interest rate risk makes this fund category suitable for investors targeting funds for a medium timeframe of three to five years. Typically, this category of funds is considered low to moderate risk on the Risk-o-Meter.

xvi.) Floater Fund:

Floater funds belong to a category that invests in bonds with interest rates linked to a benchmark that can fluctuate. Returns in this category will increase when the economy experiences rising interest rates and decrease when the opposite occurs. This provides a level of flexibility and protection against interest rate fluctuations. While floater funds are considered a relatively lower-risk method of investing in debt funds, they still expose investors to credit risk.

5.) Mutual Fund Types in India – Hybrid Funds

Hybrid funds combine equity and debt in varying proportions to suit different investor profiles. These categories were previously known as balanced funds until SEBI’s categorization changed. Now termed hybrid funds, they offer a more accurate representation of their composition.

i.) Hybrid Fund and the Fruit Salad

Let’s say Hybrid Funds are fruit salad– they have apples, bananas, and grapes in different proportions.

ii.) Apples (Stocks):

Apples are like stocks. They have the potential to grow and provide a sweet return, but they also come with some risk. Just like stocks can be volatile, apples might be sweet or a bit tart.

iii.) Bananas (Debt Bonds):

Bananas are like bonds. They offer a steady and predictable return, much like the steady energy bananas provide. However, they might not offer as much excitement or growth as apples.

iv.) Grapes (Cash or Money Market Instruments):

Grapes represent the liquidity aspect, similar to having cash. They’re easy to pluck and consume, representing the quick availability of funds in money market instruments.

V.) Hybrid Fund (Fruit Salad):

Mix of Apples, Bananas, and Grapes Now, imagine a skilled chef (fund manager) combining apples, bananas, and grapes in a bowl. The resulting fruit salad is your hybrid fund. By blending different fruits, you get a mix of flavors, textures, and nutritional benefits.

Let’s now explore the different types of hybrid funds. There is a total of six hybrid funds

• Conservative Hybrid Fund: Contains 75% to 90% in debt and 10% to 25% in equity. Suitable for income-seeking investors wanting stability with some growth.
• Balanced Hybrid Fund: Holds between 40% and 60% in debt and equity. Tax treatment doesn’t receive the equity fund benefit due to its structure.
• Aggressive Hybrid Fund: Comprises 65% to 80% equity and 20% to 35% debt. Gets equity tax treatment, offering returns similar to large-cap funds with lower risk.
• Balanced Advantage Fund (Dynamic Asset Allocation Fund): Allows the fund manager flexibility to move between debt and equity without limits. Higher risk due to manager decisions, returns typically lower than large-cap funds.
• Multi-Asset Allocation Fund: Permits investment across at least three asset classes with a minimum of 10% each. High-risk category relying on the fund manager’s asset allocation skills.
• Arbitrage Funds: Exploit price differences between spot and futures markets. Offers returns higher than liquid funds but not comparable to equity. Tax advantages due to equity fund treatment.
• Equity Savings Category: Invests a minimum of 65% in equity and 10% in debt and allows arbitrage. Returns are akin to conservative hybrid funds, with favorable tax treatment due to the equity component.

Choosing the right hybrid fund depends on your risk tolerance, financial goals, and understanding of each category’s composition and tax implications. Keep in mind the risk metrics, tax treatment, and your overall portfolio strategy when making investment decisions.

6.) Mutual Fund Types in India – Solution-oriented categories:

These are funds designed to provide personalized solutions, especially for planning retirement and saving for children’s futures. You can’t take your money out for five years unless you reach retirement age, or your child turns eighteen before that time. For retirement funds, you can exit after the five-year lock-in or if you retire before that period. In children’s funds, you can leave earlier if your child turns eighteen before five years old.

Over time, the average return in both categories has been similar to the overall stock market, but these funds have higher costs. The lock-in is helpful for people who get nervous when the market goes down and might want to pull out.

The lock-in makes them keep their money in the fund for at least five years. If you can handle the ups and downs of the market and stick with a regular stock market fund, that might be a cheaper option in the long run with similar or better returns.

So, these were the types of funds that every investor should know before investing any money in Mutual Funds. Now, let’s talk about passive funds– what they are and how one should invest in them.

7.) Mutual Fund Types in India – Other Funds

Before we venture into the other funds, we need to know what the passive funds are, as the Index/ETFs follow a passive style of investing.

What are passive funds?

Here is a category of funds that every investor must know–Passive Funds. So, what are passive funds? Unlike active funds, which are managed by fund managers making decisions on buying and selling assets to outperform the benchmark index, passive funds aim to replicate the performance of a specific index.

In active funds, fund managers make decisions to beat the benchmark and provide potentially higher returns. Meanwhile, passive funds aim to mimic the performance of a specific index, providing investors with an easy way to invest in all the stocks or bonds within that index.

Benefits of Passive Funds:

Low Costs:

One of the significant benefits of passive funds is their lower costs. Since they aim to replicate a specific market index, they involve less active management, reducing fees compared to actively managed funds.

Diversification:

Passive funds typically track a broad market index, providing investors with instant diversification. This means your money is spread across various assets, reducing the impact of poor performance on any single investment.

Market Performance:

Passive funds aim to mimic the performance of a market index. By doing so, we can essentially ride the overall market trends, potentially benefiting from long-term market growth.

Transparency:

These funds are transparent about their holdings because they follow a predetermined index. We can easily see what assets are in the fund, promoting clarity about where their money is invested.

Simplicity:

Passive funds are straightforward. They don’t require constant monitoring or intricate strategies. This simplicity can be attractive to investors who prefer a hands-off approach to their investments.

Consistency:

Since passive funds aim to replicate an index, there’s a level of consistency in the investment approach. This predictability can be comforting for investors who prefer a steady and reliable strategy.

Indices in India:

Bellwether indices in India include S&P BSE Sensex and Nifty 50, Nifty Next 50, and so on, offering an average annual return of around 14% over the past thirty years.

Now, let’s know about the types of passive funds

i) Index Funds and ETFs:

Index funds are a type of passive fund that copies the performance of a specific index. They work like other Mutual Funds but used to be more expensive. However, low-cost index funds have recently been introduced for benchmarks like the Sensex and Nifty 50, making them more available to regular investors.

Exchange-traded funds (ETFs) are another type of passive fund listed on the stock market, allowing daily trading. Unlike index funds, ETFs need a Demat account for trading. ETFs show live prices during market hours but might face challenges with how easy it is to buy or sell depending on market demand.

Gold ETFs were among the first ETFs in the Indian market. Silver ETFs and index funds are relatively new as of 2022. Passive funds can be used to give portfolio exposure to metals like gold and silver.

Index funds are often recommended for regular investors who want a simple and cheaper option. Look at the expense ratio and tracking error when deciding. Traders who actively participate in the market might not need ETFs. They can trade the whole market without intraday trading through ETFs.

ii)Fund of Funds and Overseas Funds:

This is the last category of funds we are going to talk about– FoFs and Overseas Funds. What are they?

Now, a Mutual Fund that invests in multiple other Mutual Funds is known as a fund of funds (FoF). The concept aims to offer investors diversification by consolidating various funds into one product. There was an early attempt with Optimix AMC in 2006 in India, but it folded within two years. Present-day FoFs primarily invest in schemes of the same fund house and are used for life-cycle funds and overseas funds, offering a simplified option for investors.

FoFs have gained attention for facilitating investment in exchange-traded Funds (ETFs) without the complexities associated with direct ETF investment. For instance, the Bharat Bond Fund of Funds exclusively invests in Bharat Bond ETF.

Overseas FoFs provide an opportunity for geographical diversification in foreign stocks without the need to navigate international brokerages. These funds bear the expenses of the underlying fund and can charge investors an expense ratio within SEBI limits.

8.) Conclusion:

Investing our money is an art in itself, and this is why– the wiser you are, the more you make money. Being financially wise is all about making yourself aware of different investment schemes, understanding the market dynamics, and, more importantly, choosing the right place to invest.

The bottom line is you don’t need all 37 Mutual Fund categories. Instead, you should focus on selecting funds that align with your financial goals and risk tolerance. It’s important to strike a balance between equity and debt in your investment portfolio. Different types of funds are suitable for different timeframes. So, simplifying the selection process by choosing a category based on your goals can help you handle the diversity of all the fund options more effectively. This cannot be accomplished by following amateur advice on social media platforms like Quora, Facebook, Twitter, etc. A professional financial planner will guide you through the process of investing in Mutual Funds.

Happy Investing!