Direct & Indirect Taxes, Tax Ready Reckoner, Tax Management, Tax Act. & Rules, Tax Planning & Tax Savings.

Direct & Indirect Taxes, Tax Ready Reckoner, Tax Management, Tax Act. & Rules, Tax Planning & Tax Savings.

Types of Mutual Funds

Every investor has a different requirement for his investments. No matter what your requirement is, there is always a type of mutual fund that fits your objective. Mutual funds can be subdivided in different types depending upon various criteria:

Types of Mutual Funds
Types of Mutual Funds

(A) Based on Fund Schemes:

1. Open Ended Mutual Funds: –

The most popular type. These are funds in which you can enter or exit anytime. They are not time bound. Open-end mutual funds typically do not limit the number of shares they can offer, and are bought and sold on demand. When an investor purchases shares in an open-end fund, the fund issues those shares and when someone sells shares, they are bought back by the fund.

In case of open-ended funds, an investor can purchase or sell units of an open-ended mutual fund at any time after the closure of NFO. The NFO is usually open for a maximum period of 30 days. Investment in these funds can be made through systematic investment plans (SIPs) and systematic withdrawal plans (SWPs).

In open-ended mutual funds, units are purchased and sold on demand at the net asset value of the fund.  The NAV fluctuates every day based on the prices of the stocks and bonds in the market. There is no limitation on the number of units of the mutual fund that can be issued. There is no set maturity period for these funds. Once an investor redeems the units of an open-ended fund, the units are taken off the market.  However, an investor has to pay exit loads for units that are sold within 1 year.

The fund is professionally managed by the fund manager. This scheme is a great option for investors who do not want to actively monitor their investments but are looking at optimal returns.

Examples :

>>        ICICI Prudential Technology Fund

>>        Aditya Birla Sun Life Digital India Fund

>>        TATA Digital India Fund

(i)      Advantages of investing in Open-ended Mutual Funds

– Access to liquidity:

There are no restrictions on the investor to redeem the units of an open-ended fund. This provides access to liquidity to the investors at any time they want. Moreover, the investors can redeem the funds as per the net asset value as on the day of redemption.

– Past performance:

Investors of these funds can track the performance of the funds. The historical data available helps the investor take the best investment decision.

– Various systematic options available:

These funds allow investors to make use of systematic plans for making investments and withdrawal. The investor can choose from SIPs, SWPs and systematic transfer plans.

– Professionally managed plans:

There is an experienced fund manager who manages the fund. These managers have the expertise, experience, and resources to make the right investment decision for the investors.

Diversified portfolios:

Open-ended funds invest a range of assets. The stocks belong to a variety of industries and companies. A diversified portfolio helps to reduce the risks associated with investments.

– Higher returns:

These funds provide better returns in the long run compared to other schemes. For an investor with a short-term investment horizon, open-ended funds offer the perfect solution.

(ii)    Who should Invest in Open-ended Mutual Funds ?

These funds are best suited for investors who want easy access to liquidity without any restriction. Investment in these funds can also be considered by investors who are looking to diversify their investment portfolios.

As per SEBI, an investor of a mutual fund can be Indian residents above the age of 18, Non-resident Indians (NRIs) and Persons of Indian Origin (PIOs) residing abroad, companies (including public sector undertakings), corporate bodies, trusts (through trustees) and cooperative societies, religious and charitable trusts (through trustees), and private trusts authorised to invest in mutual fund schemes under their trust deeds, foreign institutional investors registered with SEBI, and other individuals or institutions, as approved by asset management companies, so long they conform to SEBI regulations.

2. Close Ended Mutual Funds: –

After the closure of an initial offer, new investors cannot enter, nor can existing investors exit till the term of the scheme ends. These funds are listed on stock exchange and you can sell fund units on it, but liquidity is very low.

In a close-ended mutual fund, a fixed number of units are issued which are traded on the stock exchange. A closed-end fund works like an exchange-traded fund (ETF).

According to the SEBI guidelines, a mutual fund is to be launched through a New Fund Offer, which can be open for a maximum of 30 days. The funds are then traded in the open market like shares. The price of the fund is regulated by the demand and supply forces of the market.

With closed-ended mutual funds, only a fixed number of units of the mutual fund are released in the market. The units of such a mutual fund can be purchased only during the NFO period. The units can be redeemed only after the maturity of the fund. This is generally between 3 – 7 yrs. This helps the fund manager to freely use the funds to attain the overall objective of the mutual fund.

For example, when you invest in a five-year closed-ended scheme, you are given a fixed number of units. You can redeem them at the end of five years.

(i)      Advantages of investing in a close-ended mutual fund.

Stability:

A close-ended fund can be redeemed only on the expiry of the maturity period. This helps the fund managers to build a stable asset base, and employ the right investment strategy. The worry of maintaining liquidity is absent due to the lock-in period.

See also  Benefits of Investing in Mutual Fund and its Association
Demand and supply based market price:

Just the way stock price is decided upon by market forces, the NAV of a closed-ended scheme is determined by the demand and supply of the units. So, if the demand for a particular closed-ended scheme goes up and the supply remains low, then the units would fetch a higher price, over and above the NAV of the particular scheme. This helps in compounding money in the investment over time.

Liquidity and flexibility of decision-making:

Some close-ended funds provide an option of selling your mutual fund units back to the mutual fund house through periodic repurchase at NAV-related prices. SEBI regulations dictate that fund houses provide at least one of the two exit routes for investors: the repurchase facility or through listing on stock exchanges.

(ii)    Who should invest in a close-ended mutual fund?

Close-ended funds need a lump sum investment and do not offer a redemption option until maturity. Hence, investors with ready and investable capital and an investment horizon that goes with the maturity date of the scheme can opt for closed-ended mutual funds. Further, the risks and returns should be carefully assessed, based on the asset allocation of the scheme.

(iii)   Taxation in case of Close-ended Mutual Fund

Equity and debt funds have different taxation schemes. Therefore, in the case of close-ended mutual funds, the tax rates depend on the percentage of investments made by the scheme in equity and debt.

If the fund has invested 65% or more of its total assets in equity and equity-related instruments, then it is treated as an equity fund for taxation purposes.

If the fund has invested at least 65% of its total assets in debt instruments, then it is treated as a debt fund for taxation purposes.

Make sure to go through the offer document carefully, and check the asset allocation that the scheme holds to understand the tax rates.

(iv)   List of Close-ended Mutual Funds in India

Based on the performance over the last 5 yrs, here is a small list of some close-ended mutual funds operational in India:

>>        SBI Tax Advantage Fund – Series III – Regular Plan

>>        ICICI Prudential Growth Fund – Series 2

>>        SBI Tax Advantage Fund – Series II

>>        ICICI Prudential Growth Fund – Series I

>>        ICICI Prudential R.I.G.H.T. Fund

(v)     Difference between Open ended and Close ended Funds

Basis Closed Ended Funds Open Ended Funds
No of units outstanding Fixed as decided in NFO Can issue units regularly based on demand
Term Difficult to exit before the end of term of the scheme There are no entry- exit terms
Units to be sold The unit cost and number of units to be sold are fixed There is no such restriction regarding number of units to be sold
Timing You can enter only in a small window of time, open during NFO You can invest anytime and chose your own investment time
Popularity Less popular and holds about 12% assets of Mutual Funds Much more popular and holds about 88% assets of Mutual Funds
Examples These categories are mostly Closed Ended- Capital Protection Funds, Fixed Maturity Plans (FMPs) There are lot of Open Ended Debt Funds categories such as Liquid Funds, Short Duration Funds, Money
Market Funds, Corporate Bond Funds etc.

3. Interval Mutual Funds: –

Very few such funds are present in Indian market. These funds combine the characteristics of both closed-end and open-ended funds. These do not permit regular buying and selling as these remain closed for most of the time but open for a time interval predefined by the fund, wherein units can be redeemed, or new units can be bought. Like Close ended funds, these too can be traded on the stock exchange.

These funds have the characteristic feature of investing in non-liquid assets like business loans, private and commercial property. These unconventional assets are not listed on the stock exchange. Though these funds largely invest in debt market, the asset class can also comprise those from the equity market.

i.       Features of Interval Mutual Fund

Allows higher liquidity:

Interval mutual funds allow higher liquidity as you can invest your money for a specific time period according to your financial requirements. You can also choose to continue in the investment from one interval to the other. This is known as rollover of funds. There is no mandatory redemption at maturity. You must, however, note that interval funds cannot be redeemed before maturity. Even in the case of an emergency, where you want to exit the funds, you are not allowed to do so.

Interest rate protection:

As compared to open-ended funds, interval mutual funds are better as it is protected from interest rate risk. As your money is locked-in for a specific period, you are protected from interest rate fluctuations. On an average, interval funds provide you with annual returns ranging from 6% to 8.5%. You must, however, note that these funds do not provide very high returns. If you are risk-averse and want a fixed income from your investment, then these are best suited for you.

Better for short-term goals:

If you are looking for short-term returns, then interval mutual funds are the best. A lump sum amount is provided at the end of the maturity date, which can be utilised for your financial goals.

(B). Based on Management of Funds:

i. Actively Managed Funds: –

These are the funds, in which fund managers actively pick securities based on their own research and analysis. These funds are compared to benchmarks which are mostly popular indices. There are many top-rated fund managers who consistently deliver exceptional results. In India, most of the Mutual Fund investments are done in Actively Managed funds as fund managers consistently beat the benchmark and create an Alpha (returns over and above the predicted ones).

Example:

  • ARK Innovation ETF (ARKK)
  • First Trust Long/Short Equity ETF (FTLS)
  • WisdomTree Emerging Markets Local Debt Fund (ELD)
  • Pimco Enhanced Short Maturity Active ETF (MINT)
  • FormulaFolios Tactical Income ETF (FFTI)
  • SPDR DoubleLine Total Return Tactical ETF (TOTL)

ii. Passively Managed Funds: –

These are funds in which fund managers replicate an index with the same stocks and in the same proportion. They are also called as Index Funds or ETFs. Here the fund manager tries to replicate the index performance with little tracking error as the fund is subject to inflows and outflows. These funds have lower expense ratio and are gaining popularity but still lag their actively managed counterparts by quite a bit.

In passive funds, the fund manager does not actively choose what stocks will make up the fund. This is one of the reasons passive funds are easier to invest than active funds. Investors buy passive funds when they want their returns to be in line with the market. These funds are low-cost funds as there are no costs involved in selecting stocks and researching.

See also  Debt Mutual Fund – A brief Concept before Invest

Passive funds are of two types, such as -.

(1). Index Funds

As the name suggests, an Index Mutual Fund invests in stocks that imitate a stock market index like the NSE Nifty, BSE Sensex, etc. These are passively managed funds which means that the fund manager invests in the same securities as present in the underlying index in the same proportion and doesn’t change the portfolio composition.

Index Funds are an open-ended scheme where the investors buy and redeem units of the Mutual Funds at the net-asset values. In other words, the performance of an index fund is dependent on the performance of a particular index. Index funds contain shares in a similar proportion as they are in a particular index.

(2). Exchange Traded Funds (ETFs)

An exchange traded fund (ETF) is a type of security that tracks an index, sector, commodity, or other asset, but which can be purchased or sold on a stock exchange the same way a regular stock can. An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities. ETFs can even be structured to track specific investment strategies.

The units of exchange-traded funds are randomly listed on a stock exchange. Investors buy and sell units at real-time prices through Demat account.

(C). Based on Assets Invested In:

i. Debt Funds: –

These types of Mutual Funds invest their assets only in Debt (Fixed Income) Instruments such as Corporate Bonds, Debentures, Govt. Securities, etc. Their overall risk profile is low.

All these instruments have a pre-decided maturity date and interest rate that the buyer can earn on maturity – hence the name fixed-income securities. The returns are usually not affected by fluctuations in the market. Therefore, debt securities are considered to be low-risk investment options.

>          IDFC Government Securities Fund – Constant Maturity Fund

>          IDFC Government Securities Fund Investment Plan

>          ICICI Prudential Constant Maturity Gilt Fund

ii. Equity Funds: –

Equity Funds invest their assets in Stock market. These are also known as Stock Funds. These are the highest risk Mutual Funds.

You give money to a fund, and the fund invests this money in stocks. The gains or losses, whatever they may be, accrue to you. … Equity funds are legally permitted to charge up to 2.25 per cent per annum of the money it manages as its expenses.

Equity funds are an easy and economical way to invest in the stock market. … Another big reason equity funds are the way to go for most investors: Like all mutual funds, they offer diversification at a discount. The average investor doesn’t have the time or cash to build a broad portfolio one stock or bond at a time.

General equity funds include: … Growth and income funds, which invest in larger, established companies that offer the potential for capital appreciation but also pay regular dividends. Equity-income funds, which primarily invest in dividend-paying stocks.

iii. Liquid Funds: –

Liquid funds are a category debt mutual funds and these funds invest their assets in low maturity Money market instruments such as treasury bills, commercial papers, Certificate of Deposits, fixed deposits and any other form of debt securities., , etc. which have maturities of 1 to 180 days. They are the least risky Mutual Fund type.

iv. Hybrid Funds: –

These funds invest their money in both Equity and Debt instruments. Ratio varies from fund to fund. These funds are medium risk type and give you the best of both equity and debt funds.

As the name suggests, hybrid funds are a combination of equity and debt investments which are designed to meet the investment objective of the scheme. Each hybrid fund has a different combination of equity and debt targeted at different types of investors.

Hybrid funds are considered to be riskier than debt funds but safer than equity funds. They tend to offer better returns than debt funds and are preferred by many low-risk investors.

(D) Based on Investment Objective of Funds:

i. Growth Funds: –

Growth fund invests in stocks of companies which offer promising returns. Investors invest in the fund with the only goal of achieving capital appreciation. Along with high returns, the risks are also high. While investing, the fund house eliminates the stocks of companies with high dividend pay-outs. This type of fund experience high returns when the market is bullish

These are equity-based funds that invest primarily in Stock Markets. While picking stocks, these funds look for potential to grow faster than the others. The fund managers mostly invest in stocks that have low dividend yields and high growth potential.

ii. Value Funds: –

In order to understand Value Mutual Fund, let’s first talk about value investing strategy.

When an investor (or a fund manager) adopts a value investing strategy, he looks for stocks which are undervalued and trade for less than their respective intrinsic values. There are many companies in the market whose stock price is not the true indicator of their worth. They are intrinsically more valuable and have a lot of potentials to grow. The intrinsic value of a company is calculated by considering its financials, business model, competitive position, management team, etc. If the company’s market value is less than its intrinsic value, then it is considered to have ‘value’.

These are also Equity based funds that invest in undervalued stocks with a potential for appreciation, but such stocks are usually ignored by the investing community. It is a more conservative approach of investing. They invest typically in stocks with high dividend yield and low P/E ratio.

iii. Income Funds: –

Income funds mainly focus on generating regular income for the investors by investing in high dividend-generating stocks, government securities, certificate of deposits, corporate bonds, money market instruments and debentures.

These funds invest primarily in Debt instruments and will give you regular dividends/interest and are known for capital protection.

Income Funds are a type of debt funds. Invest in debt instruments like debentures, corporate bonds, government securities, etc. for a longer duration. The Securities and Exchange Board of India (SEBI) classifies Income Funds as those debt funds whose Macaulay Duration is 4 years and more. Therefore, there are two types of debt funds which fall into the category of Income Mutual Funds:

(i)         Medium to Long Duration Fund – Macaulay Duration = Between four and seven years

(ii)        Long Duration Fund – Macaulay Duration = More than seven years

(E) Special Funds:

i. Index Funds: –

An index fund is a mutual fund that imitates the portfolio of an index. These funds are also known as index-tied or index-tracked mutual funds.

Index funds often catch investors’ attention as they intend to replicate the performance of their underlying index– like the Sensex or the Nifty. All the stocks in these indices will find some representation in their investment portfolio. This theoretically ensures a performance identical to that of the index, which is being tracked. The low expense ratio is its main USP

See also  Net Asset Value (NAV) of Mutual Fund Scheme

Index funds are not actively managed funds, thus incurs low expenses. They do not aim at outperforming the market, but instead to track an index. They help an investor manage or balance the risks in their investment portfolio

Index funds closely follow the stock indices they track. For instance, a scheme that tracks the Sensex will invest in the 30 stocks that comprise the benchmark index of the BSE. Type of Passively Managed Funds.

ii. ETFs (Exchange Traded Funds): –

An ETF, short for Exchange Traded Fund, is just like a stock and can be also called a basket of securities that also trade on the stock market. Exchange traded funds pool the financial resources of several people and use it to purchase various tradable monetary assets such as shares, debt securities such as bonds and derivatives. Most ETFs are registered with the Securities and Exchange Board of India (SEBI). It is an appealing option for investors with limited expertise in the stock market.

They are essentially Index Funds that are listed and traded on exchanges just like stocks. Another type of Passively Managed Funds.

iii. Sectoral/Thematic Funds: –

Sector funds and thematic funds belong to the category of equity mutual funds. … Sector funds focus on specific sectors or industry like banking, pharma, information technology, real estate, energy, etc. Thematic funds, on the other hand, invest in stocks which are well-defined around a particular opportunity.

These are a type of Equity Funds, which invest their assets only in one focused sector/theme. Some popular sector funds are in Banking, Technology, Pharma and Infrastructure sector.

iv. Tax Saving Funds: –

Tax saving mutual funds are just like any other mutual funds with an added tax-saving benefit. The special feature of this type of mutual fund is that the investments made in the tax-saving mutual funds are eligible for tax benefits under section 80C of the Indian Income Tax Act.

ELSS mutual funds are also referred to as the tax-saving mutual funds. The provisions of Section 80C of the Income Tax Act, 1961, allows you to claim tax deductions of up to Rs 1,50,000. ELSS is the best investment option under this Section. By investing in these mutual funds, you get the dual benefit of tax deductions and wealth accumulation over time.

v. International Funds: –

An international fund is a mutual fund that can invest in companies located anywhere in the world outside of its investors’ country of residence.

These mutual funds invest in companies outside India. They help you to invest and get an exposure to Global companies.

As the name suggests, an international mutual fund invests in companies in foreign countries. Hence, these funds are also called Foreign Mutual Funds or Overseas Funds. Over the last decade, the awareness of investment opportunities around the globe has increased. Investors want to explore international markets and tap into their earning potential. Hence, many international funds have been launched with different portfolio compositions and structures.

vi. Retirement Funds: –

These are solution oriented Mutual Funds in new SEBI categorization and have a 5-year lock in.

Retirement funds, also known as pension funds, are investment options that allow an individual to save a certain portion of their income for their retirement. These funds offer a regular source of finance after one retires; a retiree receives annuity on their investment until their demise.

Pension funds are invested on the investor’s behalf, and the income generated from that investment is contributed as the interest provided on the pool of funds. These offer a fixed benefit, as it does not depend on asset return and market fluctuations.

Retirement mutual fund plans usually invest in low-risk investment options, like Government-securities, to ensure steady returns. Pension funds usually offer up to 11% interest depending on the policy and investments, making them best suited for retirement planning than any of the alternatives.

vii.   Children Funds:

These are solution oriented Mutual Funds in new SEBI categorization and have a 5-year lock in.

Children’s fund is a form of mutual fund with specific child-related goals and terms. These are a commonly availed investment option, acting as solution-oriented plans for the rising cost of education and other essential expenses.

Most mutual fund child plan invests in both equity and debt portfolios. Investors can also choose between higher debt and higher equity-based investment depending on their risk appetite and time horizon.

These mutual funds come with a minimum lock-in period of 5 years, whereas they can be extended until the child becomes an adult. Children’s mutual funds prohibit an investor to withdraw the money until the policy matures, making it a suitable long-term investment option for most individuals. It also protects an investor against market volatility to some extent. Holding the investment despite market fluctuations ensures greater return than liquidising it whenever market dips.

%d bloggers like this: