Mutual Funds : Types of Mutual Funds

    In our last post we introduced Mutual Funds and some of their details. In this post we will discuss more about mutual fund, like types of mutual funds and taxation on them. Major problem which retail investor face is choosing the fund. There are lots of options available. In this post we will try to explain different types of funds which are available in the market.
    Mutual funds are pool of money collected from various investors. This pool of money is invested in various bonds, equities, securities and so on by fund managers of asset management companies. Mutual fund categorization is based on the type of investment made by this pool of money. This categorization helps user to identify the funds based on time and returns expectations.

Mutual Fund Categorization

    Mutual funds are classified in a variety of ways. These categorization depends on various factors like time of closure, asset class and so on.

The first category of funds based on time of closure. These are :

Open-ended funds

    Open Ended-do not have a specific date when the scheme will be closed. These funds buy and sell units on a continuous basis and. This way open ended funds allow investors to enter and exit as per their convenience. The units can be purchased and sold even after the initial offering (NFO) period (in case of new funds). The units are bought and sold at NAV declared by the fund. The number of outstanding units goes up or down every time the fund house sells or repurchases the existing units. Thus total number of units of an open-ended mutual fund keeps varying. The fund size expansion happens when the fund house sells more units than it repurchases as more money is flowing in.

Close-ended funds

Close Ended schemes have a specific tenure. The unit capital of closed ended funds is fixed and they sell a specific number of units. Unlike in open-ended funds, investors cannot buy the units of a closed-ended fund after its NFO period is over. This means that new investors cannot enter, nor can existing investors exit till the term of the scheme ends. However, to provide a platform for investors to exit before the term, the fund houses list their closed-ended schemes on a stock exchange. Trading on a stock exchange enables investors to buy and sell units through a broker in the same manner as transacting the shares of a company. The number of outstanding units of a closed-ended fund does not change as a result of trading on the stock exchange. The closed-ended funds are free from the worry of regular and sudden redemption and their fund managers are not worried about the fund size.

Next category of funds are based on equities and non equities. These are:  

Non Equity Funds:

Non-equity mutual fund space consists not just of the debt funds but also all other funds that hold less than 65% of their portfolio in equity, fund of funds, international funds and gold funds. Some of the non equity funds are:

• Debt Funds: Debt funds are low risk investment instrument and best suited for investor who does not want to take much risk and seek steady income. These Funds invest predominantly in rated debt / fixed income securities like corporate bonds, debentures, government securities, commercial papers and other money market instruments. 

• Liquid Funds: These funds are best suited for short term investors. These funds invest in highly liquid money market instruments and provide easy liquidity. The period of investment in these funds could be as short as a day. 

• Gilt Funds: These funds invest in Central and State Government securities and are best suited for the medium to long-term investors who are averse to risk. Government securities have no default risk.

Equity Funds:

Equity mutual funds are most popular funds which have high risk in short term. However investors can expect high capital return in long run. In Equity mutual funds, maximum part of the corpus is invested in stock market. The structure depends on the objective of the scheme. Depending on their investment objectives, equity mutual funds can be classified as follows:

• Large Cap Equity Funds: These funds are those which invest a large portion of their corpus in companies with large market capitalization (greater than 1000 crores or blue chip companies). This type of fund is known to offer stability and sustainable returns, over a period of time as these companies have proven track records and are too big to fail.

• Mid and Small Cap Equity Funds: Another type of equity mutual fund is called mid-cap funds. In these funds the corpus is used to invests in stocks of mid-size or emerging companies and businesses. Likewise equity funds which invest in stocks of small-size companies with low market capitalization are called small cap equity funds.

• Diversified Equity Funds: These funds invest in companies across different sectors and market capitalization and hence reduce the amount of risk in the fund. Diversification helps prevent events that could affect a single sector for affecting the fund, and hence reduce risk. They are generally meant for investors who seek exposure across the market and do not want to be restricted to any particular sector.

• Thematic Equity Funds: These funds are also known as sectoral funds. These funds invest in securities of specific sectors such as Pharma, IT, FMCG, Banking, Logistics, Power and Infrastructure. So, the performance of these schemes depends on the performance of the respective sector. These funds may give higher returns, but they also come with increased risks and rewards - highest of all equity mutual funds.

• Balanced Funds: This Mutual Fund scheme allows investors to enjoy growth and income at regular intervals as the funds are invested in equities and fixed income securities. This is ideal for the cautiously aggressive investor, as they can enjoy good returns and growth options simultaneously.

• Index Funds: These investments replicate the movement of benchmark indices like Nifty, Sensex, etc. NAV of such schemes rise and fall in accordance with the rise and fall in the index.

• Equity Linked Savings Scheme: These fund are considered as mutual fund alternative of PPF or other intruments which saves tax under 80C. But there is a lock in period of three years in ELSS.

Taxation on Mutual Funds

In case of equity funds:

• Short Term Capital Gain will be applicable if units are sold before completing one year. Currently short term capital gain is taxed @15%.

•  Long Term Capital Gain will be applicable if units are sold before completing one year. Currently long term capital gains are tax free.

•  Dividends in the hands of investors are tax free.

• Dividend distribution tax is deducted by the AMCs.

In case of debt funds:

• Short Term Capital Gain will be applicable if units are sold before completing three year. Currently short term capital gain is taxed as per the slab.

• Long Term Capital Gain will be applicable if units are sold before completing one year. Currently long term capital gain is taxed @15% after the benefit of indexation.

•  Dividends in the hands of investors are tax free.

• While Dividend distribution tax will get deducted @ 25% in case of Individual/HUF/NRI and @ 30% in case of corporates.

    These are the various types of mutual fund scheme available for investors. When it comes to selecting a Mutual Fund scheme to invest in, it completely depends on your risk appetite, returns, growth, income and stability. So think about it carefully and make a wise decision. Also don't let the word risk scare you. A calculated risk is always a better choice.