Types Of Mutual Funds. | All you need to know.

Mutual funds offer several such schemes to cater to the needs of different types of investors. The objective of the scheme is announced at the time of scheme launch. Investors can decide to invest in only schemes that offer them the kind of financial market exposure that they are looking for. 

Mutual funds schemes can be classified in various ways, depending on how they are structured and the nature of investments they make. 

Basically mutual funds can be classified on the basis of three catogaries 

1. Based on Organisation Structure

• Open Ended
• Closed Ended
• Interval Fund

2. Based on Investment Style

• Active
• Passive

3. Based on Portfolio

• Equity
• Debt
• Hybrid
• Gold

1. Based on Organisation Structure : Open Ended, Closed Ended and Interval Fund

Open-Ended schemes are open for investors to enter or exit at any time, even after the NFO.

When existing investors buy additional units or new investors buy units of the open-end scheme, it is called a sale transaction (or subscription). It happens at a sale price, which is equal to the NAV. 

When investors choose to return any of their units to the scheme and get back their equivalent value, it is called a re-purchase transaction (or redemption). This happens at a re-purchase price (i.e. redemption price) that is linked to the NAV. 

Although some unit-holders may exit from the open-end scheme, wholly or partly, the scheme continues operations with the remaining investors. The scheme does not have any kind of time frame in which it is to be closed. 

Continuous entry and exit of investors implies that the unit capital in an open-ended fund would keep changing on a regular basis.

Closed-Ended funds have a fixed maturity. Investors can buy units of a closed-end scheme, from the fund, only during its NFO. The fund makes arrangements for the units to be traded, post-NFO in the stock exchange/s. This is done through a listing of the scheme in one or more stock exchanges. Such listing is compulsory for closed-end schemes.
 

After the NFO, investors who want to buy units of a closed-end fund will have to find a seller for those units in the stock exchange. Similarly, investors who want to sell units of a closed-end fund will have to find a buyer for those units in the stock exchange. This is done through the screen-based trading system of the stock exchange (as in the case of shares). 

Transactions in the stock exchange need to be effected through members (brokers) in a stock exchange, and may call for a demat account in the name of the investor.   

Interval Funds combine features of both open-end and closed-end schemes. They are largely closed-end, but become open-end during pre-specified time periods. 

For instance, an interval scheme might become open-end between January 1 to 15, and July 1 to 15, each year. The benefit for investors is that, unlike in a purely closed-end scheme, they are not completely dependent on the stock exchange to be able to buy or sell units of the interval fund. There is a transaction period (January 1 to 15 and July 1 to 15, in this example), when both subscription and redemption may be made to and from the scheme). Transaction period has to be of minimum 2 working days, as per SEBI Regulations. 

The gap between two successive transaction periods (January 15 to July 1, in this example) is called interval period. The minimum duration of an interval period is 15 days. Subscription and redemption is not permitted during the interval period. 

2. Based on Investment Style :  Actively Managed Funds and Passive Funds 

Actively managed funds are funds where the fund manager has the flexibility to choose the investment portfolio, within the broad parameters of the investment objective of the scheme. Since this increases the role of the fund manager, the expenses for running the fund turn out to be higher. Investors expect actively managed funds to perform better than the market. 

Passive fund invests on the basis of a specified index, whose performance it seeks to track. Thus, a passive fund, tracking the CNX Nifty or S&P BSE Sensex, would buy only the shares that are part of the composition of that index. The proportion of each share in the scheme’s portfolio would also be the same as the weightage assigned to the share in the computation of the index. 

Therefore, the performance of these funds tends to mirror the concerned index. Yet, there are gaps in the performance of these funds as compared to the index. This gap in performance is its tracking error. It can be positive or negative i.e. the passive fund performance can be better or worse than the concerned index, for various reasons. 

Passive funds are not designed to perform better than the market. On account of linkage to the index, they are also called index schemes. Since the portfolio is determined by the index itself, the fund manager has no role in deciding on investments. Therefore, these schemes have low running costs. 

The index, on which a passively managed scheme is constructed, is called its benchmark. Similarly, even active schemes have a benchmark – a standard against which scheme performance can be compared. A benchmark is announced when every scheme, active or passive, is launched. 

Exchange traded funds (ETFs) are a type of open-end index fund that are listed in the stock exchange. Investors need a demat account for buying units of ETF. Post-NFO, retail investors can transact in ETF units only in the stock exchange. 

3. Based on Portfolio : Equity, Debt, Hybrid & Gold Funds 

Equity Funds : A scheme might have an investment objective to invest largely in equity shares and equity-related investments like convertible debentures. Such schemes are called equity schemes. 

Types of Equity Funds :

Diversified equity fund is a category of equity funds that invest in a diverse mix of equities that cut across sectors (such as banking, pharma, etc.). They may be managed actively or passively. The RGESS tax benefit is available only for diversified equity schemes that invest in companies, which fulfil specified criteria. Such schemes are sold in the market as RGESS schemes. 

Sector funds invest in only a specific sector. For example, a banking sector fund will invest in only shares of banking companies. Gold sector fund will invest in only shares of gold-related companies. 

Thematic funds invest in line with an investment theme. For example, an infrastructure thematic fund might invest in shares of companies that are into infrastructure construction, infrastructure toll-collection, cement, steel, telecom, power etc. The investment is thus more broad-based than a sector fund; but narrower than a diversified equity fund. 

Equity Linked Savings Schemes (ELSS) offer income tax benefits to investors. However, the investor cannot sell the Units for at least 3 years. ELSS schemes invest in a range of sectors. 

Equity Income / Dividend Yield Schemes invest in multiple sectors. They select shares that fluctuate less, and therefore, dividend represents a larger proportion of the returns earned by the scheme from those shares. The NAV of such equity schemes are expected to fluctuate lesser than other categories of equity schemes.

Debt Funds : Schemes with an investment objective that limits them to investments in debt securities like Treasury Bills, Government Securities, Bonds and Debentures are called debt funds or income funds. 

Types of Debt Funds :

Gilt funds invest in only treasury bills and government securities (such as those issued by Reserve Bank of India or Government of India), which do not have a credit risk. Credit risk means the risk that the issuer of the security defaults in repayment. 

Diversified debt funds on the other hand, invest in a mix of government and non-government debt securities. 

Fixed maturity plans (FMPs) are a kind of debt fund, where the investment portfolio is closely aligned to the maturity of the scheme. AMCs tend to structure the scheme around pre-identified investments. Under the regulations, FMPs need to be structured as closed-end scheme. Thanks to these characteristics, the fund manager has little ongoing role in deciding on the investment options in FMPs. 

Such a portfolio construction gives more clarity to investors on the likely returns if they stay invested in the scheme until its maturity. This helps them compare the returns with alternative investments like bank deposits. However, the returns in a FMP are subject to market risk until they mature. Further, on maturity, the issuer may not be in a position to pay the redemption amount i.e. there is a credit risk too. 

Every FMP is a closed-end debt fund; however, every closed-end debt fund is not a FMP. In closed-end debt funds that are not FMP, the fund manager keeps shuffling the debt portfolio in line with changes in the market. Therefore, the returns from non-FMP closed-end debt funds are more unpredictable than the returns from FMP.
 
Liquid schemes or money market funds are a variant of debt schemes that invest only in debt securities where the moneys will be repaid within 91 days. These are widely recognized to be the lowest in risk among all kinds of mutual fund schemes. 

Hybrid funds : have an investment charter that provides for a reasonable level of investment in both debt and equity. 

Types of Hybrid Funds :

Monthly Income Plan (MIP) seeks to declare a dividend every month, though the dividend is not guaranteed. It invests largely in debt securities. However, a small percentage is invested in equity shares to improve the scheme’s yield.

 
Capital Protection Oriented Schemes are closed-end schemes, which are structured to ensure that investors get their principal back, irrespective of what happens to the market. This is ideally done by making adequate investment in Government Securities. The remaining corpus is invested in the market.

  
Even if the market-based investment becomes completely worthless (a rare possibility), the investor is assured of getting back the principal invested, out of the maturity moneys received on the government security. 

Some capital protection oriented schemes offer the capital protection through complex portfolio optimisation strategies that dynamically hedge the portfolio. 

Some schemes of this type are structured differently. The investment is made in good quality debt securities issued by companies, rather than Central Government Securities. Since any borrower other than the government can default, there is an element or risk of loss of principal in funds structured in this manner. 

Gold Funds : Gold funds invest in gold and gold-related securities. 

Types of Gold Funds :

Gold Exchange Traded Fund (Gold ETF) is like an open-end index fund that invests in gold. The NAV of such funds moves in line with gold prices in the market, though some tracking error is possible. Investors need a demat account for buying units of Gold ETF. Post-NFO, retail investors can transact in ETF units only in the stock exchange. 

Gold Funds (also called Gold Savings Funds) invest in Gold ETF units. They are costlier than the Gold ETF. 

Unlike Gold ETF, Gold funds make it possible for retail investors to transact in the units, directly with the scheme, even post-NFO. Further, since SIP is possible, and the investor does not need a demat account, Gold Funds are quite popular among retail investors. 

Gold Sector Funds invest in shares of companies engaged in gold mining and processing. Though gold prices influence these shares, the prices of these shares are more closely linked to the profitability and gold reserves of the companies. Therefore, NAV of these funds do not closely mirror gold prices. 

Thanks for reading. We hope this was informative to you. Read Investment Related more articles.

• MUTUAL FUNDS - ADVANTAGES & RISKS | ALL YOU NEED TO KNOW.
  
• Thinking of investing in Mutual Funds? Know about India's best performing Flexi Cap Mutual Funds SIP in 2021.
• MUTUAL FUNDS 2021 - AN OVERVIEW
• What precautions you should take before investing in the stock market?
• What is portfolio, management and diversification? All you need to know.
• What are various options available for investment?