A mutual fund is a professionally managed firm of collective investments that pools money from many investors and invests it in stocks, bonds, short term money market instruments, and or other securities.
In a mutual fund, the fund manager, who is also known as the portfolio manager, trades the fund’s underlying securities, realizing capital gains or losses, and collects the dividend or interest income.
The investment proceeds are then passed along to the individual investors.
The value of a share of the mutual fund, known as the Net Asset Value per share (NAV), is calculated daily based on the total value of the fund divided by the number of shares currently issued and outstanding.
What are the Types of Mutual Funds Available?
Following are the classifications of different types of mutual funds:
1. Equity Funds
Equity funds are considered to be the more risky funds as compared to other fund types, but they also provide higher returns than other funds.
An investor looking to invest in an equity fund should invest for the long term, like, for 3 years or more.
There are different types of equity funds each falling into different risk brackets.
In the order of decreasing risk level, there are following types of equity funds:
Aggressive Growth Funds
In aggressive growth funds, fund managers aspire for maximum capital appreciation and invest in less researched shares of speculative nature.
Because of these speculative investments, aggressive growth funds become more volatile and thus, are prone to higher risk than other equity funds.
Growth funds also invest for capital appreciation (with a time horizon of 3 to 5 years), but they are different from aggressive growth funds in the sense that they invest in companies that are expected to outperform the market in the future. Key Advantages and Disadvantages of Mutual Funds.
Without entirely adopting speculative strategies, growth funds invest in those companies that are expected to post above-average earnings in the future.
Equity Income or Dividend Yield Funds
The objective of equity income or dividend yield equity funds is to generate high recurring income and steady capital appreciation for investors by investing in those companies which issue high dividends (such as power or utility companies whose share fluctuate comparatively lesser than other companies share prices).
Equity income or dividend yield equity funds are generally exposed to the lowest risk level as compared to other equity funds.
Diversified Equity Funds
Except for a small portion of investment in the liquid money market, diversified equity funds invest mainly in equities without any concentration on a particular sector.
These funds are well diversified and reduce sector-specific or company-specific risk.
However, like all other funds, diversified equity funds to are exposed to equity market risk.
Equity Index Funds
Equity index funds have the objective to match the performance of a specific stock market index.
The portfolio of these funds comprises of the same companies that form the index and is constituted in the same proportion as the index.
Value funds invest in those companies that have sound fundamentals and whose share prices are currently undervalued.
The portfolio of these funds comprises of shares that are trading at a low price to earnings ratio(market price per share/earning per share) and a low market to book value (fundamental value) ratio.
Specialty funds have stated criteria for investments and their portfolio comprises of only those companies that meet their criteria for some specialty funds could be to invest/not to invest in particular regions/companies.
Specialty funds are concentrated and thus, are comparatively riskier than diversified funds.
2. Money Market/Liquid Funds
Money market/liquid funds invest in the short term (maturing within one year) interest-bearing debt instruments.
These securities are highly liquid and provide safety of investment, thus making money market/liquid funds the safest investment option when compared with other mutual fund types.
3. Hybrid Funds
Hybrid Funds, as the name suggests, are those funds whose portfolio includes a blend of equities, debts, and money market securities.
Hybrid funds have an equal proportion of debt and equity in their portfolio.
4. Debt/Income Funds
Funds that invest in medium to long term debt instruments issued by private companies, banks, financial institutions, governments, and other entities belonging to various sectors (like infrastructure companies, etc.) are known as debt/income funds.
Debt funds are low-risk profile funds that seek to generate fixed current income (and not capital appreciation) to investors.
To ensure regular income to the investor, debt (or income) funds distribute a large fraction of their surplus to investors.
5. Gilt Funds
Gilt funds are also known as government securities in India, gilt funds invest in government papers having medium to long term maturity periods.
Issued by the government, these investments have little credit risk and provide safety of principal to the investors.
However, like all debt funds, gilt funds to are exposed to interest rate risk.
6. Commodity Funds
Those funds that focus on investing in different commodities (like metals, food grains, crude oil, etc). or commodity companies or commodity futures contracts are termed as commodity funds.
7. Real Estate Funds
Funds that invest directly in real estate or land to real estate developers or invest shares securitized assets of housing finance companies are known as specialized real estate funds.
The objective of these funds may generate regular income for investors or capital appreciation.
8. Exchange-Traded Funds (ETF)
Exchange-traded funds provide investors with combined benefits of a closed-end and an open-end mutual fund.
Exchange-traded funds follow stock market indices and are traded on stock exchanges like single stock at index-linked prices.
9. Fund of Funds
Mutual funds that do not invest in financial or physical assets, but do invest in other mutual funds schemes offered by different AMCs, is known as a fund of funds.