Classification of Mutual Funds

Over the years Mutual Fund industry has evolved a lot. As per need of an investor many different type of funds have been added over time. Different type of funds differ in terms of risk they posses and returns they offer. Mutual fund industry is regulated by SEBI ( The Securities and Exchange Board of India ) and they need to follow the rules set by SEBI.

Many new investors are not aware of type of mutual funds available in India. This post is to make you aware of the available options to invest. Mutual funds can be categorized either on the basis of maturity or investment goal or investment objective.

Mutual funds based on maturity period

On the basis of maturity we can divide mutual funds as open-ended and close-ended funds.
 

i) Close Ended Funds

These funds can be purchased only during the new fund offer (NFO) period. As the name suggests these funds are closed for a fixed maturity period and cannot be purchased or sold during this period. Units purchased during NFO period can be redeemed at a fixed maturity date. Different type of close-ended funds are:-

• Capital Protection Plan - Main objective of this fund is to protect principal amount i.e. capital with reasonable returns. These mainly invest in fixed income securities with very little exposure to equity. Returns are low for this scheme.   
• Fixed Maturity Plan - As the name suggests, these funds have a fixed maturity period. They mostly invest in debt instruments which mature in line with with the maturity of the scheme. FMPs are passively managed and therefore, the expenses are generally lower than actively managed schemes.

ii) Open Ended Funds

 These funds can be purchased or redeemed throughout the year unlike close-ended funds. They do not have a fixed maturity date. Units are allocated based on the NAV. These funds provide better liquidity than close-ended funds as they can be purchased or redeemed any day. These funds are not limited to debt funds or fixed income securities, they invest in shares, securities, gold etc based on investment objective. An investor can exit anytime from this type of schemes by redeeming all the units.

Mutual funds based on investment goal or option

Investor have different investment goals. Some investor needs regular income, while some need money after a period of time and they let their investment grow till their goal is achieved.

   

i) Growth option - If you choose growth option then profits made by the fund are invested back into it. So, when the scheme gains, the NAV of the scheme increases. You will not receive any intermediate returns. Only way to make gain is to sell or redeem the units. If you don't need regular income then you can choose this option. This is good for investors who have long term goal.

     

ii) Dividend Option - In dividend option, profit made by the fund will be not be invested back. Instead, it will be distributed back to the investor time to time. This profit which is distributed is known as dividend and is tax free for the investor. There is no guarantee on the amount and frequency of dividend. If scheme is not making much profit or is in loss then it will not distribute any dividend. No profit means no dividend. Since the amount is not invested back to scheme, NAV of dividend option is always less than the growth option. In case you need regular income, you can go for this option (in debt fund).

iii) Dividend re-investment Option - This option is a mix of growth and dividend option. Here dividend is declared but not issued to the investors. Dividends declared by the scheme are re-invested back to the same mutual fund for additional units. So, instead of getting dividends in the form of cash you are getting it in the form of extra units. One may face the risk of exit load as the new units will again have the lock in of one year in case of equity fund and three years in case of debt fund. Growth option is better than this option.

          

              

Mutual funds based on investment objective

Below funds are the actual funds in which you can invest. All these funds will have both growth and dividend option. You can choose the fund which suits your need along with the investment option.

i) Equity funds - These funds invest more than 65% of its portfolio in equity stocks or shares of companies. These are considered to be more risky but also provide high returns. They are best suited for investors who are looking for long term growth.

   

ii) Debt funds - These funds invest mostly in debt instruments and bonds like government securities, corporate bonds etc. If you are looking for less risky funds and want better returns than Fixed deposits (FD) then these funds are for you. You can choose dividend option of debt funds if you want regular income.

   

iii) Balanced or hybrid funds - These funds invest in both equity and debt instruments. Good part is that the tax treatment of balanced fund is same as that of equity funds. Risk is moderate with these funds. These funds quickly switch from equity to debt and vice versa depending on market conditions. If you have to choose only one fund then you can select a balanced fund. This is best suited for beginners as they don't have to worry much about rising or falling market. Fund manager itself switches between equity and debt.

   

iv) Index funds - These funds are passive funds as fund manager doesn't do any research and invests blindly in Index (Sensex, Nifty, Bank Nifty etc). Returns from these funds are in line with the index. Expense ratio of these funds is less as compared to actively managed fund. If you believe that market is going to perform very good then only choose these funds.

   

v) ELSS funds - These are Equity Linked Saving Scheme (ELSS) funds. If you are looking to save tax then you can choose these funds. Amount invested in these funds gives a tax rebate under section 80C of IT act. They have the shortest lock in period of 3 years when compared to other tax saving schemes like PPF, NSC etc. Risk is moderate and returns are comparatively higher than any other tax saving scheme.

  

vi) Exchange traded funds (ETF) -  These funds are listed and traded on stock exchange unlike all other funds which can be purchased or redeemed only through MF houses. Most ETFs track an index like Nitfy, PSU Bank, a commodity like Gold or a basket of assets. These funds are managed passively and therefore, offers lower service charges. Other advantage of these funds is that they can be traded throughout day on stock exchange and therefore, they offer lot of liquidity. 

  

vii) Global or international funds - International funds (or foreign funds) invests in assets located outside country i.e. foreign country. They cannot invest in assets located in the investor's own country. Global funds doesn't have this limitation and they can invest globally including investor's own country. These funds mostly invest in emerging markets. It is difficult to rate them safer or riskier. These funds can provide diversification to your portfolio since returns in foreign countries may not be correlated with returns in your home country.