Although mutual funds are quite popular in India, in my experience I have noticed that people are still not aware of different aspects of mutual funds. There are numerous different types of mutual funds available yet people fail to make an educated decision simply because they are not aware of these.
SEBI has classified mutual funds in five categories in India. Equity funds, funds that invest mainly in the stocks. Debt funds, funds that invest mainly in debt-related securities like bonds, G-sec, etc. Hybrid funds, the funds that invest both in the equities and the debt securities. Solution oriented funds. Other schemes which include Index funds/ETFs and Fund of Funds. These categories have multiple sub-categories under them, which will be explained in detail in this article.
Equity Mutual Funds
As the name suggests these funds invest majority potion in equity, i.e. stocks of listed companies and related securities. These are the most popular category of mutual funds. Any mutual fund in this category has at least 65% of total assets in equity. There are 11 sub-categories of equity mutual funds.
1. Large Cap Mutual Funds:
These mutual funds have at least 80% of their assets as stocks of large-cap companies. Large-cap companies are the top 100 companies according to market capitalization. This provides a portfolio comprising of companies that have performed well and can be considered as leaders in their sectors.
Risk Associated: Among all equity funds these funds have the lowest risk. But do not be misguided, these are high-risk products and a stock market fall can wipe away all your gains.
Time Period: The time period for the entire equity mutual fund category should be long term. Personally, I don’t advise anyone to look into equity if the investment is for 5 years or less. These funds you can consider for a time period of 5 or more years.
2. Mid-Cap Mutual Funds
Mid-cap companies are the companies that rank from 101 to 250 based on market capitalization. Mid-cap mutual funds have at least 65% of their assets in the form of stocks of mid-cap companies. The companies in this category can provide substantial growth, but as always higher the return potential higher is the risk. These funds have shown substantial movement in both positive and negative direction in the past.
Risk Associated: These are funds with very high risk. These funds have provided substantial gains to investors in the past, but the losses were also quite high.
Time Period: I generally advise people to stay away if the investment is for less than 7 years. But generally, you should consider them only for a time period of around 10 years and more.
3. Small-Cap Mutual Funds
Small-cap companies are those which rank 251 and higher based on market capitalization. These companies are some of the riskiest among all listed companies. They can provide huge returns to the investor but they can also wipe out your capitals, forget about losing your returns these stocks can wipe out your investment too when they start moving downwards. A small-cap mutual fund holds at least 65% of its assets as stocks of small-cap companies.
Risk Involved: These mutual funds have a very high risk. Personally, I have zero investment in small-cap funds. Please do ample research and risk analysis before investing in small-cap funds.
Time Period: I advise people to not go for a small-cap fund for their goals. But, if you choose a small-cap fund, only consider it for around 15 years and more.
4. Large and Mid-Cap Mutual Funds
These funds invest at least 35% of assets in stocks of large-cap companies and at least 35% of assets in stocks of midcap companies. These funds make use of somewhat consistent performance of large-cap and high upward potential of mid-cap. They are preferred by people who want limited mid-cap exposure in their portfolio.
Risk Involved: As with every equity related product, these funds have high risk. But, the risk is a little less than mid-cap funds as they have a mixture of a large and mid-cap fund
Time Period: Not recommended for an investment of 5 years or less. People who are ready to handle more risk than large-cap and want to invest for more than 7 years can go for these funds.
5. Multi-Cap Mutual Funds
Funds having a minimum of 65% of their assets in stocks of listed companies, spread across small, medium and large-cap. These funds provide the benefit of diversification to the fullest. The risk and return of these funds depend on which type of stocks form the majority of the asset. A multi-cap fund that has a high percentage of small-cap in comparison to the mid and large-cap will have high return potential but high risk too.
Risk Involved: These funds have variable risk depending upon the composition of the assets. A high percentage of small-cap assets result in high risk while a high percentage of large-cap assets reduces the risk a little.
Time Period: Just like the risk this also depends on the composition of the assets. Higher the percentage of small-cap more should be the time period and under no circumstances would I recommend an equity fund for an investment of 7 years or less. But personally I like to stay away from these funds.
6. Dividend Yield Mutual Funds
These funds have at least 65% of their assets in the form of stocks, the majority of which are dividend-paying stock. These should not be confused with dividend option of mutual funds, these are funds that invest in dividend-paying stocks and offer both growth and dividend options. As dividend is declared by profit-making companies, these funds have stocks of companies with good profit margin in recent past.
Risk Involved: High risk as it is an equity product, but among all equity funds, these are less risky than mid-cap and small-cap.
Time Period: Do not invest for a time period of 5 years or less. Mainly suitable for long term investment.
7. Value/Contra Mutual Funds
An AMC can offer only one of these funds, both these funds should have a minimum of 65% assets in the form of stocks. The fund selection and investment in these funds are done according to value investment strategy (in value mutual funds) and according to contrarian investment strategy (in contra funds).
Risk Involved: Both these strategy tends to invest in companies with good fundamentals. But, this being an equity product and how well the strategy is being implemented, and how much the strategy itself can be relied upon, these factors make these funds quite risky. Personally I want to keep my investments super simple (KISS), and thus have zero exposure to these funds.
Time Period: Strictly for long term investment.
8. Sectoral/Thematic Mutual Funds
These funds invest in stocks of companies belonging to a single sector/theme. At least 80% of the assets should be in the form of stocks of a particular sector/theme. These funds are quite volatile and sacrifice the diversification in favor of the growth potential of the sector/theme. You should only invest in these funds if you have an in-depth knowledge of that sector/theme and can handle the risk of big negative returns. It is very essential to time your entry and exit if you want to benefit from these funds.
Risk Involved: These funds have a very high risk, you might even lose the capital invested during downward trends.
Time Period: The performance hugely differ between different sectors/themes, you need to time your entry and exit. Thus it is very hard to prescribe a particular time period for these funds.
9. Focused Mutual Funds
These funds have at least 65% of their investment in the form of stocks of listed companies. But they can only choose a maximum of 30 companies to invest in. These funds choose the companies to invest in after careful and ample research. They forgo the benefits of diversification in favor of growth, making use of all the available resources to conduct the research.
Risk Involved: They are highly risky products as it is a pure equity product and on top of that it is not very diversified.
Time Period: For long term investment, preferably 7 years and more.
10. ELSS Funds
These funds work under the Equity Linked Saving Scheme of the central government, hence the name ELSS funds. They have a minimum of 80% of their investment in stocks of listed companies. The money you invest in ELSS funds in a single FY can be used for income tax deduction under section 80C. These funds have a lock-in period of 3 years. These have become quite popular as an instrument to cover equity investment goals and 80C targets. But, people do not realize the huge risk involved, these essentially function like multi-cap funds, with an even higher equity exposure and lock-in.
Risk Involved: They very high-risk funds, even more than a multi-cap fund. A multi-cap fund has to maintain a minimum of 65% equity exposure, while ELSS has to maintain a minimum of 80%. On top of that, you have a 3 year lock-in period, in case you think the market is at the start of a downtrend, you can’t pull out your money.
Time Period: Although I use to invest substantially in ELSS funds, today I prefer staying away from these. Do not be influenced by a 3-year lock-in these should be considered for more than 7 years at least.
Risk Comparison of Equity Mutual Funds
The category as a whole is of high risk. Nobody can predict the rise and fall of the equity market. All those self-proclaimed financial experts who advise that risk in equity mutual funds is only for short to medium-term are either lying or are unaware. How many lost their hard earn money in the crash of 2008, did that crash only affected short-term and medium-term investors? Where are they in the 2020 market crash? That being said among equity mutual funds some categories have a higher risk than other equity mutual funds. I have separated equity mutual funds into four categories based on the risk involved.
Highest risk equity MFs: Small-cap equity mutual funds | Sectoral/Thematic equity mutual funds
Second highest risk equity MFs: ELSS | Focused equity mutual funds | Midcap equity mutual funds | Value/Contra equity mutual funds
Third highest risk equity MFs: Large and Mid-cap equity mutual funds | Multi-cap equity mutual funds
Least risk among equity MFs: Dividend Yield equity mutual funds | Large-cap equity mutual funds | Equity Index Fund*
*Although SEBI puts Index funds in a different category, you can use equity index funds for your investments of 5 and more years. Index funds are safer than actively managed large cap funds, as no extra risk is taken for the purpose of beating benchmark returns.
Debt Mutual Funds
Unlike equity mutual funds debt mutual funds are not that popular. This results in a lack of information making it difficult for people to understand and choose an appropriate debt mutual fund. That is why before going into types of debt mutual funds I would like to discuss the risk associated with debt mutual funds. Mainly because it will make understanding the different categories easy, and also there is a quite popular myth that debt mutual funds are risk-free.
Risk Associated With Debt Mutual Funds
There are two types of risk which affects the debt portion of a mutual fund. Although these affects debt mutual funds the most, but it should be remembered that any mutual fund can have exposure to debt instruments.
The two type of risks are:
- Credit Risk
- Interest Rate Risk
Let’s take a look at these in a more detailed manner.
1. Credit Risk: According to Investopedia credit risk “refers to the risk that a lender may not receive the owed principal and/or interest”.
In the context of debt mutual funds, the AMCs buy/trade bonds issued by different institutions. These bonds are issued to raise money and come with a fixed maturity and rate of interest. Credit risk is the risk of bond issuing entity defaulting on these bonds, i.e. at the time of maturity the issuer of the bond is unable to pay the maturity amount fully. AMC may hold the bond till maturity or sell it to make money, a prospect of default decreases the market value of the bond and the AMC might not get the full money at maturity. This is the credit risk associated with bonds.
The magnitude of credit risk can be determined by the rating given by various credit rating agencies. In the case of RBI and the government “SOV” rating is given, which means a sovereign guarantee, bonds/securities issued by them have the least probability of default. The higher the credit rating, the least is the chances of default thus the least credit risk.
2. Interest Rate Risk: Interest rate changes have a direct effect on the prices of the bonds. The market price of a bond is inversely linked to the interest rates, this means that if the interest rate increases the market price of the bond falls and visa-versa. This affects the bond with a longer maturity period more than the bonds with shorter maturity periods.
This is due to what is called opportunity cost. Imagine you have invested in a bond that offers an interest of 5%. After some time the interest rates increase and a newly issued bond of the same maturity period offers 6% interest. Now you are losing an opportunity of earning 1% additional interest. This is the opportunity cost, the longer the maturity period of the bond more will be the opportunity cost lost.
So, in conclusion, debt funds may not be as risky as equity mutual funds but that doesn’t mean that they are risk-free. Also, debt funds should not be used with the expectation of generating returns and thus I do not recommend risky debt funds like Credit Risk Funds. Any time the credit rating goes down your NAV will be affected. Anytime the interest rates go up your NAV will be affected. Now let us take a look at the types of debt mutual funds.
1. Overnight Funds
These funds invest in overnight securities with maturity of 1 business day. You may keep your investments in these funds for as long as you like but the asset of the fund is invested in overnight securities. These funds make gains through the interest only, due to such a small maturity period of the securities held. They are among the safest mutual funds, but at the same time their returns are also the lowest among debt mutual funds
Risk Involved: These funds are one of the safest when it comes to mutual funds. The credit risk in these funds is among the lowest and the interest rate risk is almost zero.
Time Period: You can park the money which you might need in the next 2 to 3 months in these funds.
2. Liquid Funds
These funds invest in securities with a maturity of 91 days. These funds hold securities of high credit rating and thus have high liquidity. These funds are very useful for your short term goals and can also be used to park unused funds for a few months. These funds have a very low risk but at the same time, the return from these funds is also quite low.
Risk Involved: Just like overnight funds, these funds are quite safe. They usually invest in securities with a high credit rating and the duration is low enough to make the interest rate risk almost negligible.
Time Period: You can use these funds for your recurring goal, they are suitable for the time period of a few months and above.
3. Ultra Short Duration Funds
These funds invest in securities that have a Macaulay maturity duration between 3 months and 6 months. There is no restriction on the credit quality of the securities in which money is invested investments should be made after checking the credit rating of the securities, the credit risk can vary a lot between funds of different AMCs. You can expect returns similar to the FDs of nationalized banks.
Risk Involved: In case of these funds there is low interest rate risk, but not negligible like liquid and overnight funds. Credit risk can vary a lot between two ultra short duration funds, as it depends on the securities in which money is being invested. It is advisable to check the credit rating and choose a safe fund.
Time Period: Suitable for an investment of 1 year and above. Can be considered for the debt portion of your short term goals.
4. Low Duration Funds
These funds invest in securities that have a Macaulay duration between 6 months and 12 months. Just like ultra short duration funds credit risk in these funds can vary a lot as no restriction on the credit quality of the securities is there. You can expect a return that is comparable to the FDs in the nationalized banks.
Risk Involved: As the maturity duration of securities held increases, the interest rate risk increases. But still, the interest rate risk in these funds is low, although more than ultra short duration funds. The credit risk of these funds depends on the credit quality of the securities held, you should check the credit ratings before investing.
Time Period: These funds can be used for an investment of 1 year or more.
5. Money Market Funds
These funds invest in money market securities having maturity up to 1 year. The money market securities are commercial papers, commercial bills, treasury bills, CDs, govt. securities, and other instruments as specified by RBI. These securities have a very high credit rating thus these funds have very low credit risk. The return of these funds is the same as low-risk ultra short duration and low duration funds and a little more than liquid funds.
Risk Involved: As these funds invest in securities with high credit rating the credit risk in these funds is quite low. The duration of these securities is up to 1 year thus the interest rate risk is also very low.
Time Period: These funds can be used for your short term goals of 1 year and above.
6. Short Duration Funds
These funds invest in debt instruments but the portfolio must have a Macaulay duration between 1 year and 3 years. In these funds too, there is no restriction on the credit quality of the securities, thus securities with low credit ratings may be involved, increasing the credit risk. The return of these depends on the credit quality of securities held, these funds can give more return than ultra short duration and low duration funds of comparable credit quality.
Risk Involved: These funds have a little higher duration and thus the interest rate risk is also higher than all the debt funds mentioned earlier. The credit risk can vary from one fund to others depending on the credit rating of the securities held by the fund.
Time Period: These funds can be used for the debt portion of your medium to long term goals. You should consider them for the investment of 3 years and above.
7. Medium Duration Funds
These funds invest in debt instruments of varying credit rating and duration but the Macaulay duration of their portfolio should be between 3 years and 4 years. No restriction on the credit quality of the securities. They can give returns which are slightly more than short-duration funds of the same credit quality, but the interest rate risk is also a little more.
Risk Involved: As there is no restriction on the credit quality of the assets held, the credit risk can vary from fund to fund, please check the credit ratings and choose the safer fund. The interest rate risk rises with the rise in duration, so these funds have a higher interest rate risk than the debt funds mentioned above.
Time Period: These funds should be considered for investments of 3 years and above.
8. Medium to Long Duration Funds
The Macaulay duration of the portfolio of these funds is between 4 years and 7 years. These funds invest in debt instruments of different credit quality, but the portfolio duration must be between the stipulated period.
Risk Involved: As no restriction on credit quality is there, the credit risk changes from fund to fund. The interest rate risk is quite high in these funds. This makes these funds quite risky.
Time Period: The debt portion of your portfolio is not for generating returns, but for capital protection. Thus risky debt instruments should be completely avoided. I recommend you not to go for these funds.
9. Long Duration Fund
The Macaulay duration of the portfolio should be greater than 7 years. These funds invest in debt instruments with different credit ratings but have to maintain the portfolio duration at all times. These are highly susceptible to interest rate risk.
Risk Involved: These funds can invest in debt instruments of any credit quality. Thus the credit risk can vary from very high to very low. The interest rate risk in these funds is among the highest.
Time Period: These funds are quite risky, thus I would recommend investors to stay away from these funds. Keep the debt portion of your portfolio as risk-free as possible.
10. Dynamic Funds
These funds invest in debt instruments of varied credit quality and varied duration. There is no restriction on the duration of the portfolio. The fund managers use the freedom to generate higher returns. The returns may vary from fund to fund depending upon the fund manager and how much risk the fund is taking.
Risk Involved: The composition of the portfolio of these funds changes quite frequently, and the duration of the portfolio is also very dynamic. This makes the risk vary not only among the funds but also in the same fund the risk varies from time to time. At a time when it seems that interest rate might decrease the fund manager invests in securities with higher duration thus increasing the interest rate risk, and visa-versa. This makes these funds high-risk debt instruments.
Time Period: This being a debt product with high risk, I would not recommend these funds at all.
11. Corporate Funds
Minimum 80% of the total assets of these funds are in the form of corporate bonds of the highest credit rating. These funds have a restriction on credit quality thus they have a low credit risk. The fund managers generate returns by buying or selling securities of different maturity duration based on the interest rate change anticipation. If it seems that the interest rates are going to decrease, securities of higher maturity duration are bought, and visa-versa. The return of these funds is higher than liquid and money market funds.
Risk Involved: The credit quality of these funds is comparably high as 80% of the securities are of the highest credit rating, this makes the credit risk low. But, there is no restriction on the duration of these securities, the fund managers use this to generate returns, but as a result, these funds have a higher interest rate risk.
Time Period: These funds can be used by people who have a higher risk appetite, but only for long terms. You can use these funds for investment of 5 years and above.
12. Credit Risk Funds
65% of the total asset is invested in corporate bonds of credit rating below than the highest rating. This fund has an additional restriction on the naming of the funds, words, and phrases which highlight only the return aspect cannot be used. These funds can offer the highest return in the debt mutual fund category, but they also come with higher risk.
Risk Involved: These funds have quite a high risk, as there is a restriction on having 65% of assets of below highest credit rating, and no restriction on duration of securities, thus interest rate risk can vary a lot. These funds are mainly focused on generating returns from debt securities and thus have a high risk.
Time Period: Once again I would advise you to stay away from these funds, the debt portion of your portfolio is not for generating returns, it’s for capital protection.
13. Banking and PSU Funds
Minimum 80% of total assets are in the form of debt instruments of banks, Public Sector Undertakings, Public Financial Institutions. You can understand them as corporate bond funds, but only of banks and PSUs. Although there is no restriction on credit quality, the debt instruments of these institutions are among some of the safest in India. In the case of banks, RBI always comes to their rescue and in the case of PSUs, there is implicit sovereign security of the government. They can provide returns that are more than liquid funds or money market funds, but less than corporate bond funds.
Risk Involved: The credit risk is not very high as 80% of the assets are in the form of relatively safer debt instruments. But the interest rate risk is higher as there is no restriction on the duration of the portfolio.
Time Period: They can be considered for investment of 5 years and above, mainly for your long term goals.
14. Gilt Funds
Minimum 80% of the total assets should be invested in government securities (G-sec). There is no restriction on the duration of the securities, the fund managers may buy or sell securities of different durations in anticipation of the change in interest rate.
Risk Involved: In the case of credit risk, these are the safest funds as G-sec have a sovereign guarantee. But when it comes to interest rate risk they are very risky as there is no restriction on the duration of the securities held.
Time Period: These funds have a high level of risk, combined with highly inconsistent performance. If you want to invest in these funds only do so for the long term, 7 years and above.
15. Gilt Funds With 10 Year Constant Duration
Minimum 80% of total assets are in the form of government securities and the Macaulay duration of the portfolio is 10 years. This is simply a gilt fund with an additional restriction of portfolio duration.
Risk Involved: These funds have the lowest credit risk but a high interest rate risk. The interest rate risk in these funds is so high that it wipes out the benefits of the lowest credit risk.
Time Period: The level of interest rate risk is very high. The investor can consider these funds for 10 years and above.
16. Floater Funds
These funds have a minimum of 65% of their assets invested in floating rate debt instruments. There is no restriction on the credit quality thus they can invest in securities of varied credit rating. The securities they invest in have a floating rate, which means that the coupon rate (rate offered by the debt instrument) changes in response to the change in interest rate. This means that no matter the maturity duration the interest rate risk remains low. The return these funds can offer depends on the credit risk they are taking, risky instruments with low credit rating can offer higher returns.
Risk Involved: The credit risk can vary from fund to fund, you should check the credit ratings of the assets before investing. The interest rate risk is quite low. Thus a floater fund with good credit quality assets will have low overall risk.
Time Period: A fund with good credit quality can be used for investment of 1 year and above.
Hybrid Mutual Funds
A hybrid mutual fund invests in more than one type of security in a substantial percentage, for example, bonds and stocks. These funds are highly diversified and protect the investors from harms of concentrated portfolios. By investing in different types of securities these funds try to take benefit of lower risk of securities like bonds and higher return potential of securities like stocks. Let’s have a look at different types of hybrid funds.
1. Conservative Hybrid Funds
These funds invest in debt related and equity-related securities. Investment in equity-related securities is between 10% and 25% and in debt-related securities between 75% and 90%. With such a low percentage of equity exposure, their performance and risk depend on the type of debt securities the fund is having. Their performance is comparable to some of the risky debt mutual funds.
Risk Involved: Equity risk is present but as the equity exposure is quite low, equity risk is also very low. The major risk comes from the credit quality of the debt securities and interest rate risk which is determined by the maturity duration of debt securities held.
Time Period: I do not recommend these funds, not because they are risky, but because they do not provide much of a benefit. If you want a little higher returns from a debt-oriented fund, you can look into debt funds that take on a higher risk to generate returns, like credit risk funds.
2. Balanced Hybrid / Aggressive Hybrid Funds
An AMC can offer only one of these two funds.
In the case of balanced hybrid funds investment in equity is between 40% and 60% and the rest is in debt-related securities. These funds generate returns mainly from their equity investment and the debt instrument act as a safeguard for your capital. These are good for people with a moderate investment strategy in need to generate some return.
In case aggressive hybrid funds investment in equity is between 65% and 80% and rest is invested in debt related instruments. These funds are quite risky as the debt portion is very small in comparison to the equity portion. Although the debt portion minimizes the risk to some extent these funds are still quite volatile.
Risk Involved: These funds have a significant equity portion, thus market risk related to equity is present. This equity-related risk is a little less in balanced hybrid funds. On top of that, the credit risk and interest rate risk related to debt portfolio are also there, this is a little less for aggressive balanced funds.
Time Period: Both these funds should not be considered for the short term. For an investment of 7 years and above, a balanced hybrid fund can be looked into, while the aggressive hybrid fund should only be considered for an investment of 10 years and above.
3. Dynamic Asset Allocation Funds OR Balanced Advantage Funds
Both names are used to describe the same category of funds. In these funds, investment is made in both equity and debt-related securities. But, the percentage of equity and/or debt is not fixed and is determined dynamically based on market conditions and fund manager’s decisions. The underlying principle is that at a time when the economy is doing good equity exposure is increased to generate more returns, but this increases risk. At times when the market is facing downtrends, debt exposure is increased to safeguard the investment.
Risk Involved: The main risk arises from the equity portion of the portfolio. As the percentage of equity is not fixed the risk can also vary a lot. This uncertainty of how much risk is there is also a big risk in itself. In my opinion, these funds have a high risk.
Time Period: Only for long term investment, you should consider these funds only for 10 years and above.
4. Multi Asset Allocation Funds
These funds invest in more than 3 types of assets and investment in each type of asset is a minimum of 10% of total investment. For example, a fund can invest in stocks, bonds, and gold. As with dynamic asset allocation funds these funds have ample room to vary the percentage of any asset class. This, if used properly, can generate decent returns in the upward cycle of the market and can protect the capital in a downward cycle. But, this depends a lot on the capabilities of a fund manager, and even a very capable fund manager can not predict the market with accuracy all the time, and in these funds we are talking about predicting three separate asset classes. Thus you should be aware of this fact and only invest after ample research.
Risk Involved: Every asset class has its own type of risk. Gold and equity have market-related risks and are quite volatile assets. Debt assets have credit risk and interest rate risk. The percentage of any asset class in the portfolio determines its impact on the overall risk of these funds, and this changes depending on the market condition and decisions of the fund manager. Overall these funds have a high risk.
Time Period: Should only be considered for long term investments which means above 10 year period.
5. Arbitrage Funds
I myself was unaware of this category until the beginning of 2019, only from Feb 2019 I started learning about this category, so please keep this in mind while reading what I write about this category.
The minimum investment in equity and equity-related instruments is 65%. But the main feature of these funds is how they generate returns. These funds do not generate returns by the capital appreciation of their equity portfolio, rather they use arbitrage opportunities to generate returns. Arbitrage opportunity arises when something has a different selling rate in different markets, like in case of stock difference in selling price in the cash and futures market is an arbitrage opportunity. These funds make use of such arbitrage opportunities to generate profit. These funds also hold a substantial portion of their assets in the form of cash and debt securities to further lower the risk.
Risk Involved: The returns are generated through arbitrage opportunities in these funds, due to this these funds are among some of the very low risk funds. The risk is comparable to some of the moderate risk debt funds like low duration funds. Although the risk rises sharply in case of a market crash, as arbitrage strategy can result in a loss when markets crash.
Time Period: You can use these funds for the debt portion of your medium to long duration goals. Good for an investment of 3 years and above.
6. Equity Saving Funds
These funds invest a minimum of 65% of total assets in equity, and minimum debt allocation is 10% of total assets. There is an additional condition, minimum hedged and unhedged percentage of securities help is to be declared in SID (Scheme Information Document). The unhedged part is usually used to generate returns through capital appreciation, while the hedged part is used for arbitrage opportunities. So basically these funds are a combination of equity, arbitrage, and debt. The percentage of unhedged equity held by the fund is a major determining factor for the risk the fund has. Investors should choose a fund with the lowest unhedged equity.
Risk Involved: The major risk comes in the form of unhedged equity held by the fund. The hedged equity mainly used for arbitrage and the debt portion contributes very little to the risk. You should always choose a fund with a low unhedged equity percentage to minimize your risk.
Time Period: You can look into these funds for an investment of 7 years and above.
Solution Oriented Schemes
There is nothing special in these schemes and they provide no extra benefit to an investor which some other fund can not. Any fund can replace these very easily, the only thing that differentiates them is the lock-in period. And, personally I am not a big fan of lock-in periods. So I am just going to mention the characteristics as they are mentioned in the SEBI circular, and I do not recommend them at all.
1. Retirement Funds
Scheme having a lock-in for at least 5 years or till retirement age whichever is earlier.
Retirement is a serious issue and needs a lot of planning and disciplined execution of the plan, please do not run after products like these.
2. Children’s Funds
Scheme having a lock-in for at least 5 years or till the child attains the age of majority whichever is earlier.
Every parent plans, save and invest for the future of their children, please take help of a financial planner rather than going after products like these.
1. Index Funds / ETFs
These funds replicate a particular index. At least 95% of the assets are invested in securities of the index replicated. The difference between index funds and ETFs is, in an index fund you buy/sell directly from/to the AMC at NAV unit price, while ETFs are traded in the market and you buy/sell them in the live market through your Demat account at market prices. These have a very less expense ratio and a little less risk, as no extra risk is taken in the attempt of beating the benchmark returns.
Risk Involved: The composition of the underlying asset determines the risk. A NIFTY index fund is highly risky as it is almost completely equity based. ETFs are a little riskier than the index funds, as apart from the underlying assets the units of ETFs have direct market risk. In fact, equity index funds are even less risky than large cap funds, as there is no requirement of taking any extra risk for generating better returns than benchmark.
Time Period: You can use these for the equity portion of your medium and long term goals. Although you should stay away if the investment is for 5 years or less.
You can read a detailed article I have written on Index investing and Index funds here.
2. FoFs (domestic and overseas)
These funds invest in other mutual funds. The funds in which they invest can be of the same AMC or other, they can be domestic mutual funds or mutual funds of other countries. The return of these funds depends on the performance of the funds they have invested in. These funds are mainly used by people who are looking for foreign exposure through mutual funds. These funds are costlier as they charge you expenses and invest in funds that charge them expenses. I generally stay away from these funds
Risk Involved: Mainly depends on the risk profile of the funds the asset has been invested in, if a particular FoF has invested mostly in equity funds it is bound to be riskier.
Time Period: Strickly for long durations, you can use them if you want some foreign exposure, I don’t recommend domestic FoFs.