What Are Mutual Funds?
Mutual fund refers to a large pool of money invested in proportions, in the stock exchange by sound professional expert known as the finance manager.
Mutual funds are ideal for investors who either lack large sums for investment, or for those who do not have the time to research the market, yet want to grow their wealth. The money collected in mutual funds is invested by professional fund managers according to the scheme’s stated objective. In return, the fund house charges a small fee which is deducted from the investment. The fees charged by mutual funds are regulated and are subject to certain limits specified by the Securities and Exchange Board of India (SEBI).
Actively managed mutual funds refer to those funds which are actively and attentively managed and monitored by the financial experts, whereas, Passively managed mutual funds refer to those which have a set of predefined rules and regulations. Comparatively lesser fees are charged by these financial experts.
Mutual funds are started by the Asset Management companies. Investment of money is a complex decision, finding the right avenues, the rate of return, significant timeline are the major elements or factors which need to be taken into consideration.
Net Asset Value (NAV):
- NAV abbreviation stands for “Net Asset Value”. The performance of a specified mutual fund is denoted by its Net Asset Value (NAV). As shares have a market traded price, similarly, mutual funds are assigned a net asset value per unit. The NAV of mutual funds fluctuates daily depending on the performance of the underlying assets. It is required to be disclosed on a daily basis.
- The NAV per unit is the market value of securities of a particular mutual fund divided by the total number of units of the scheme on any specified date.
NET ASSET VALUE (NAV) = Fund Assets - Fund Liabilities / Total Number of Units
Mechanism of Mutual Funds:
Lets understand the way in which mutual funds work.
- NFO Issue: The first and foremost step is the issue of a New Fund Offer (NFO). The Asset Management Company starts the mutual fund by launching its NFO. The units in an NFO are generally priced at a nominal value of Rs.10.
- Finance: After the issue, the fund houses receive the funds from the investors to make further investments as stated in the scheme. Participation in the NFO is not mandatory, investors can still invest by purchasing the units.
- Investing Activity: The fund manager will now make investments as per the scheme’s strategy. This is the core element of the mutual funds, these investments will determine the future performance of the scheme. The finance manager has to do extensive research on its portfolio.
- Return of Funds: Mutual fund returns are subject to market risks. But in the long run it has the potential to reach great highs. Once the returns are generated they are either distributed among the investors or retained for further growth. Investors can take the decison of either IDCW (Income Distribution Cum Capital withdrawal) or the growth option. The IDCW option yield lower returns than the growth option, as one receives only a part of the profits made by the fund. The growth option provides with higher returns, as it gives the benefit of compounding effect of reinvesting the profits.
Parameters to look for before making an investment:
- Start as early as possible, the time duration or tenure of investment is more important than the amount.
- Understand the probable risk associated to investment and one’s personal risk appetite.
- Thoroughly check the portfolio of the fund, the trustworthiness of the company and the track record of the mutual fund manager.
- Lump sum method: The lumpsum method refers to the way of investment whereby, the investment is made at once. It is beneficial and profitable when the market is overly undervalued.
- SIP (Systematic Investment Plan Method): SIP abbreviation stands for Systematic Investment Plan, in this method a systematic investment of a specific amount is made every month for a number of years, when the prices of the units are high, less number of units are purchased whereas, when the prices of the units are less, number of units purchased are more, it is purchased at an average price. It gives the benefit of Rupee Cost Averaging. One must make an SIP when the market is saturated and at a high level.
Advantages of Mutual Funds:
- Diversification: Mutual funds help in the diversification of funds to various sources by putting the entire money in a single place.
- Expert Supervision and Management: Mutual funds are monitored and managed by financial experts which monitor and supervise the performance of the fund.
- Liquidity: Mutual funds provides with the advantage of liquidity of funds. In Economics, liquidity refers to something which can be easily converted into cash. One can redeem the mutual funds as and when required.
- Reduced Risk: Due to the factor of diversification the risk associated to investments is reduced significantly.
- Tax Advantage: There exist mutual funds which are primarily concerned with providing tax benefits and concession in regards to income Tax. By making investments in such particular mutual funds one can avail the facility of tax advantage.
- Low Operating Costs: The cost associated to operation of mutual funds is considerably low.
- Higher Returns: Mutual funds have a history of giving higher returns in comparison to any other financial instruments.
- Investor Protection: Mutual funds work within the framework of the stock exchanges or capital markets which are regulated by the Securities and Exchange Board of India (SEBI). SEBI protects and promotes the interest of the investors.
The biggest advantage of mutual funds in comparison to any other financial instrument is that it is already diversified. The probable risks associated are reduced due to the factor of diversification. Investment in mutual funds is affordable as the units are available at nominal net asset value (NAV).
Disadvantages of Mutual Funds:
- Exit Load: Mutual fund companies levy an exit load (charge) when the redemption is done within a specified period, for example, within one year from the date of such investment. This policy is laid down to refrain the investor from exiting the scheme too early, it will not only have a negative impact on the mutual fund’s performance but also lead to negative or less returns to the investor.
- Risk: The investment in mutual funds is linked to the stock exchange and investment in securities market are subject to market risks. One has to anticipate the losses, mere diversification does not give a complete hedging from the risks. For example, investment in equity mutual funds are subject to volatility due to the fluctuating market conditions.
- Finance: After the issue of NFO, the received funds need to be invested which is the core element of the mutual fund scheme, this primarily defines its performance. The finance manager has to do extensive research and take sound financial and investment decisions inorder to make good returns.
What is an Equity Mutual Fund?
An equity fund is a mutual fund scheme that invests primarily its major proportion in equity stocks.
In the Indian context, as per current SEBI Mutual Fund Regulations, an equity mutual fund scheme must invest at least 65% of the scheme’s assets in equities and equity related instruments.
These funds have the potential to generate high returns by investing in the stocks of companies across all market capitalisations.
Equity mutual funds as the name suggests, have a major investment in the equity related instruments. The investment in equity mutual funds is risky as the value of investments can fluctuate as per the prevalent market conditions.
Type of Equity Mutual Funds:
Diversified Equity Fund or Multicap:
A diversified or a multicap mutual fund invests the funds in the large, medium and small cap companies in certain proportions. Multi-cap funds is a category of mutual fund that invest across various market capitalisations, including large-cap, mid-cap, and small-cap stocks. This diverse approach allows fund managers to make amendments as per the changing market conditions, allocating assets strategically based on prevailing opportunities.
Large Cap Funds:
The SEBI (The Securities and Exchange Board of India) has put forth a criteria for the appropriate classification of the companies. The top 100 companies listed in the stock market based on market capitalization are classified as large-cap companies. The mutual funds that make investments in the companies from the large-cap are known as large cap funds. The market cap for these companies is around Rs.20000 crores and more, and they have a strong market presence. Large-cap funds have a lesser risk profile compared to the others. In large-cap funds, they invest in stocks that are in the top 100 companies.
Mid Cap Funds:
SEBI established a rule in the year 2017, according to which companies that are ranked from 101 to 250 in terms of market capitalization are known as mid-cap companies. The market cap for these companies will be around Rs.5000 to Rs.20000 crores. The mutual funds that make investments in the companies from the mid-cap are known as mid cap funds.
Mid-cap companies also have a good track record, but the difference is noticeable compared to large-cap companies. Mid-cap funds are involved with more risk than large-cap funds. Mid-cap companies may or may not be included in broad market indexes due to their limited market presence. Mid-caps are slightly riskier than large-cap stocks and less risky than small-cap stocks.
Small Cap Funds:
The companies ranked from the 251st position onwards in terms of market capitalization are known as small-cap companies. Small Cap mutual funds are equity mutual funds that invest in small-cap stocks. Small-cap funds are those with a market capitalization of less than Rs. 5,000 crore.
The mutual funds that make investments in the companies belonging to the small-cap are known as small cap funds. Small-cap stocks are riskier than the other two. Despite the risk, these stocks have great growth potential.
Flexi Cap Funds:
- A flexi cap fund is a mutual fund that invests in a variety of stocks across different market capitalizations, including large-cap, mid-cap, and small-cap stocks. The fund manager can change the allocation of the fund based on market conditions, opportunities, and valuations.
- Flexi cap funds offer the flexibility to invest in companies across all market capitalization sizes. However, flexi-cap funds offer additional flexibility to the fund manager. They can choose to avoid mid and small-cap stocks entirely if they prefer. Moreover, they have the freedom to allocate a larger portion of the portfolio to large-cap stocks, especially during periods of economic downturn or market volatility.
- In flexi-cap funds, there are no set limits on the percentage of funds that the manager can allocate to each category, whether large-cap, mid-cap, or small-cap. This flexibility allows the fund manager to adapt the portfolio composition based on market conditions and investment strategies. However, as per the SEBI, the fund has to make at least 65% investments in equity and equity related instruments.
Equity Linked Saving Scheme (ELSS):
Equity linked saving scheme (ELSS) is a special kind of equity fund whereby, one can save taxes by investing in this fund.
Sector Mutual Fund/ Thematic:
Sectoral investment is made under this category of mutual fund. These funds in comparison to other funds are risky as returns are entirely based upon a single sector and its performance. For example, UTI transportation and logistics fund.
Contra Fund:
A contra fund is a form of mutual fund that invests in the opposite direction of the market. These funds follow a contrarian approach. In simple words, contra fund managers go against the current market trends. They look for undervalued stocks which have strong fundamentals, yet are not favoured by the market.
Contra funds invest in stocks that are now out of favour or undervalued, as opposed to popular and performing well stocks. The main motive of contra funds is to go against the current market conditions and invest in assets that are presently underperforming due to short-term factors.
Value Funds:
Value fund managers identify and invest in undervalued stocks with strong fundamentals and the potential for long-term capital appreciation.
Index Funds:
- Index fund is a popular term in the mutual fund selection category. Index funds are directly linked to the stock exchange indices. These funds are passively managed that no agent of Asset Management company is looking at where to invest the money, they already have a set of predefined rules and regulations and a framework to follow. The fund manager invest the funds in such companies which come under the index. For example, money will be entirely invested in the companies which come under the NIFTY 50.
- It is observed that Index funds carry the potential to deliver the best returns in comparison to investments made in any other mutual fund categories, as these funds are directly linked to the market thereby, provide with the accurate and high returns in the long run.
Dividend Yield Funds:
Dividend yield funds as the name suggests are those funds which primarily focus on investing in stocks or securities of companies with a history of paying high dividends relative to their share price. The mechanism of these funds is as to provide investors with regular income in the form of dividends along with the potential for capital appreciation.
DISCLAIMER:
Investment in securities market are subject to market risks, read all the related documents carefully before investing.
The information presented on this website is with the objective of imparting financial knowledge and for informational purposes only, not a substitute for any professional financial advise.
We have made sure to provide information with atmost accuracy. Regardless of anything, financial information imparted through this website should not be considered as an offer to make investment decisions.
You must consult a qualified financial advisor before making any actual investment.
