8 Common Types Of Mutual Funds – Different MF Schemes

Types of Mutual Funds Schemes

Mutual funds form a corpus to invest in various sectors of the Indian economy. They also invest in selected themes, which means investing in companies engaged in a common activity for a particular scheme.

The following article will give a broad outline of the most popular types of mutual funds schemes that are proving to be a hit among common Indian investors. 

1. Equity Mutual Funds 

The most common & Different type of mutual fund is equity funds. 

However, equity funds come in many flavors. 

To start with, there are pure equity funds that hold selected top one-hundred to two-hundred shares from Nifty 100 or Nifty 200 index which are also the largest by market capitalization.

These funds invest in blue-chip companies. 

Blue chips are those firms that have produced consistent profits over the decades, and their market capitalization exceeds ten thousand crore rupees. 

They provide stability to the markets via their consistent earnings, dividends and return ratios. 

TCS, Infosys, ITC, SBI are examples of blue-chip firms. HDFC Top 200, ICICI Prudential Blue-chip, DSP Top 100 equity funds are all top constituents of this large-cap mutual fund category. 

From an equity market perspective, these funds are the safest bet, with its constituent firms rarely crashing.

They also provide decent returns during a market upturn, easily going to double digits and having a limited downside during market reversal.

2. ELSS or Tax Saver Types Of Mutual Funds

ELSS is the second most popular category of mutual funds. 

These are tax savings fund mainly comprising equity investment. These funds have a mandatory three-year lock-in period.

The maturity proceeds are taxed at LTCG rates after this period. 

LTCG rates are currently only ten percent over capital gains that exceed one lakh rupees. Even after considering the capital gains, the return is substantially more than FDs. 

Compared to the ELSS lock-in period, the nearest lock-in period is of tax-saving FDs. that cannot be redeemed before five years.

PPFs have a minimum holding period of fifteen years. However, the tax on the mature PPF amount is nil.

The tax-saving FDs and ELSS funds both receive 80C benefits during income tax returns. One can invest a maximum amount of rupees one lakh fifty thousand per annum for both.

The invested amount is deducted from the main taxable amount during filing returns.

Although the principal amount is treated in the same manner in both cases under IT Act, 1961, however, ELSS still scores way over the FDs in two ways. 

For starter, the lock-in period is the lowest compared to tax-saving FDs and much lower than NPS or PPF. 

The maturity returns, if invested during the market downturn, cross thirteen to fourteen percent effortlessly. FDs are linked to interest rates and rarely cross eight percent and half. 

However, for such two-digit returns in Tax Saver Mutual funds, one must choose the growth or dividend re-invest option.

Such high returns are possible only in cases where the capital gains are reinvested under the growth or dividend reinvest option.

If the client takes out the profit via dividend payout, compounding returns will not occur.

Axis long-term equity, Motilal Oswal Long Term Equity, Tata India Tax savings, HSBC Tax Saver, HDFC LT Advantage are better picked among the ELSS mutual funds.

3. Knowledge on Debt Mutual Funds 

The third-largest category of mutual funds when calculated on AUM, are debt funds. 

These funds, when redeemed within one year, are subjected to tax per user’s slab. Unlike equity mutual funds, these funds do not have the luxury of getting LTCG benefit after one year only. 

Instead, these funds are termed non-equity funds and taxed at twenty percent after thirty-six months or three years.

However, it scores over the FDs are the indexation benefits. 

When the indexation ratio is applied to the buying price, it gets inflated and reflects the true price, had it been bought currently. In effect, the buying price becomes higher while the selling price remains the same. 

Therefore, capital gain decreases. Consequently, the taxation amount also becomes much lesser than twenty percent.

The tax becomes lesser than the FD maturity taxation, which is taxed at the user’s tax slab rates.

Debt funds also have an inherent advantage. They invest in are money market, corporate bonds, government bonds or gilts, government treasury bills, commercial papers, etc. 

All these are linked to the prevailing interest rates. They have a sovereign or company guarantee. Their returns are not open-ended like equity funds. 

The debt funds get capital gains in two ways. The first one is the annual interest they get from the bond instruments. 

The second gain comes from the selling price of that instrument in the secondary market. 

For example, the government offers an infrastructure bond that opens at an offer price of rupees one-thousand and eight per-cent yield per annum. Let the interest rate offered by banks for FDs at that point be seven percent. 

Subsequently, if inflation decreases, the interest rate will also subside. Let us suppose that it comes down at six-percent.

It is natural that RBI would also decrease the repo rates and banks would start lowering its own interest rates. 

Now instead of seven percent, let us assume that banks offer FD interest at six percent and half. However, the infrastructure bonds will continue yielding eight percent interest per annum while FD interest is at six and a half percent. 

Consequently, the bond’s price in the secondary market shall rise higher from rupees one-thousand owing to higher yield.

The fund house can benefit from the higher bond interest or it can gain from selling these at higher prices than acquisition in the secondary market.

Debt funds are not immune to crashes and recent ILFS, RCOM fiasco has bared the fragility of company papers and bonds. That is why another scheme of debt funds investing only in PSU banks and government PSU company’s bonds are more popular.

These have done relatively well while the private companies like ILFS, RCOM have bought many debt funds investing into its papers, to its knees. 

However, because of the mutual fund’s natural diverse investing structure, the downside risk from one or two of the constituents is somewhat mitigated from the upside of other companies in its kitty.

Before investing in any debt fund, check out its portfolio. Funds that have the maximum AAA-rated papers in their holdings are prone to least downside but the returns would also follow a steady path with no exciting upshots.

Debt funds with more of AA or further downside rated papers would produce more gains if the companies perform well, but also carries the risk of company default if company situations turn adverse.

Funds holding government securities and PSU papers are the safest bet. The return of such debt funds rarely crosses eleven to twelve percent per annum. 

These funds are also popular for being a substitute for income schemes from banks and post office, earning more returns.

However, the recent ILFS meltdown has shown the risk of default. Although defaults are very low for such schemes, however, they are not totally immune from risks.

Edelweiss Government Securities Fund, DHFL Pramerica Dynamic Bond Fund, Reliance Income Fund, and Axis Banking & PSU Debt Fund are among the best debt funds in India for trailing five years and have given an average of 9.5% returns.

4. Balanced Types Fund

The aim of the balanced funds is to provide stable capital gains. This translates into capital gains that are secured but grows at a slower rate than equity.

This is done by investing a part of the corpus in equity and the rest part of the debt. 

Balanced funds come in different risk patterns. Some are low-risk-funds which translates to lower but stable return rates while others are aggressive.

These funds yield higher returns when the markets turn higher but lose value when the markets nose-dive. However, their loss is always lesser than pure equity funds.

Balanced funds invest part of their money in equity and rest part in debt. A part may be stored aside in cash if neither of them has good return prospects.

The return and risk factor depends on the percentage that is invested in cash and in debt. 

Balanced funds that invest 60% or more of their corpus in cash are treated as equity funds and enjoy benefits of LTCG after one year. 

However, conservative funds employ more capital in debt markets and their LTCG is 20% after three years lessened by indexation. Such funds are treated to income tax slab as per users’ tax profile if redeemed before 36 months.

Dividends for balanced funds whose equity participation is below 60%, is liable for Dividend Distribution Tax (DDT), which currently comes to almost 29% of the dividend amount.

Historical returns of equity balanced funds have effortlessly moved to 14% and greater during the market upturn.

Equity balanced funds enjoy the benefit of tax-free dividends as they are treated as part of equity funds.

5. Money market or Liquid funds – Short Time Money garage

These funds invest in CDs (Commercial deposits) of reputed banks having a proper financial moat, government treasury bills of one-year tenure, promissory notes, etc.

In short, these funds do not invest in any security that is illiquid and whose maturity is over one year. 

The debt instruments that these funds invest in are frequently traded in money markets. These fulfill the borrowing needs of banks, corporations, and RBI.

The rate at which banks give short-term loans to corporations is known as the repo rate. This rate sets the base rate of interest for money market instruments.

The money market has a typical characteristic. The bonds in money markets are traded below the face value from NFO. Face value is obtained only at maturity. 

Depending on the interest rate, the demand-supply of money and economic expectations, the interest rates vary and so does the trading rate of these bonds in the secondary market.

The real interest rate varies but these short and secured debt papers give a continuous yield as promised in their bond. 

The money market instruments are accredited from CRISIL, CARE, ICRA, etc. The lower-rated debt papers give more interest as returns but carry a higher risk of default.

The risk category of a money market mutual fund depends upon the quality of debt it invests in.

These are normally short-term funds, which are useful for parking a sudden corpus of money awaiting other investment avenues.

6. Fixed Income or Pension Funds

Fixed income funds are predominantly full debt funds. Pension funds, very low-risk-funds, whatever you name it, fall under this category.

These are low-risk-funds owing to the following factors. 

They invest most of their capital in highly rated debts. The examples are CDs of PSU banks which are honored even if the bank is merged with a larger entity, the GOI bonds which are backed by the Indian Government, the Municipal bonds, State Development bonds, etc.

These are debts, which are least likely to default. And if it happens, The government normally fulfill these bonds obligations.

These funds are mostly close-ended. They cannot be retrieved before the maturity timeline. However, their units may be freely traded as ETFs. This removes the pressure of sudden huge redemption and the fund going broke. 

These factors have made such full debt funds being treated as Pension funds.

Pensioners mostly take out the interest accrued as SWP (Systemic withdrawal plan) while the principal remains with the fund creating an almost perpetual interest source that is independent of the low-interest rates that plague FDs. 8.5-9% interest income is commonly obtained through such closed-end pension funds.

SBI Regular Saving, Aditya Birla Sunlife Treasury Optimized fund, Franklin India Income Builder are among the better fixed-income funds, giving a yield of 8.5-9.5% on an average per annum.

7. Fund of Funds – low-Cost Overseas Trading

These are popularly known as F-O-F funds. These funds are passive funds and invest money into a bigger overseas fund.

The most popular among these are funds that invest the corpus into a bigger mutual fund house that invests in US equities, Gold mining, and Crude oil extraction related mining companies.

This Fund of Funds has created excellent overseas investment opportunities for common Indian investors.

One can invest in the likes of companies as Google, Facebook, Caterpillar, Amazon, etc. via these FOFs.

However, because if the overseas investment, these funds have a higher cost of operation and their expense ratio is greater than normal funds.

These funds also have levy greater withdrawal cost (1% for any withdrawal within 3 months), especially for redemption within one year.

One operational example of FOF funds is the ICICI Prudential US Bluechip fund, which follows the S&P 500 index benchmark and invests in NYSE and NASDAQ bourse blue-chip shares.

Another example of FOF is Kotak World Gold Fund. In last year, it has given an incredible 32% return along with a rise in gold prices. This passive FOF invests in the overseas Falcon Gold Equity Fund.

8. Index Funds – Low-cost Low-Risk funds

These are passively managed funds that track the index they represent (Nifty 50, Nifty 100, Nifty 200, Nifty 500, Nifty Midcap, Sensex, Bankex) and has a portfolio of shares that is an exact replica of that corresponding index in terms of each company’s shares percentage.

These shares have very low expenses as they are passively managed an easily give 12-14% returns if invested at the market trough. These funds rarely lose their value over a long time because of the diverse high-quality shares held.

These are cyclic nature funds, which always return to their mean value after a certain time.

Almost every mutual fund house has index funds that generate similar returns which vary minutely due to operational expenses of various funds.

These are one of the safest equity-oriented funds that have the equity LTCG advantage while having the lowest equity risk.

Conclusion

The above categories comprise the most popular Types Of mutual funds schemes.

Equity funds have evolved a long way and are now popular financial instruments of all seasons and all reasons.

Diverse funds are available for various needs whether that be for pension funds, children’s education or high wealth growth.

Although LTCG has been introduced both for equity and debt funds, however, they still remain attractive with only 10% LTCG for equity over one lakh capital gains and 20% for debit funds after three years with indexation benefit.

As commodity space opens up and banks and financial institutions are allowed to take part in the commodities market, more exciting mutual schemes will follow in the near future.