There are several different types of mutual funds. Before making an investment, it is important for all to understand the goals and objectives of the fund and ensure that the associated risk level is something that you are comfortable with.
Even when two mutual funds are of the same type, their returns and risks may not be the same. Ensure that you have greater understanding of mutual funds before making an investment in them. Ideally, first time investors should speak to a financial expert for helping decide which fund types are best suited to meet your financial goals and needs.
Listed below are the different types of mutual funds.
- Equity Funds
Equity funds are those which mainly invest in the shares or stocks of companies. They form the largest class of mutual funds. The investment goal of such funds is capital appreciation over long term. Since there are several types of equities, equity mutual funds are also of many different types.
Equity funds are categorized as per the market caps or size of the companies that it invests in and the growth outlook of such stock investments.
A term value equity fund makes investments in low growth but high quality companies which are not in favor with the market. Such companies are marked by low P/B or ‘price to book’ and low P/E or ‘price to earning’ ratios and high dividend returns.
Growth equity funds mainly invest in companies which are expected to show or have shown strong earnings growth, cash flows, and sales. Such companies usually have high ‘price to earnings’ ratios with no dividend payouts.
A mix between strict growth and value investments can be termed as a ‘blend’, which in plain terms means investments in stocks that are neither growth nor value companies; they are usually grouped as being just in the center.
Equity mutual funds that invest as per the size of the companies typically go for large caps with market capitalization above Rs. 10000 crores. One can calculate the market cap via multiplication of the stock price to the number of outstanding shares. Large cap companies are usually blue-chip behemoths which can easily be recognized by its name. Mid-cap companies are companies with a market cap between Rs. 5000-Rs.10000 crore. Small companies are companies with a market capitalization less than Rs.5000 crore.
The strategy of equity fund investments can be a blend of company size and investment method. For instance, a large cap value mutual fund may invest in large cap companies that are financially strong but have recently witnessed a fall in their share prices; they are thus a blend of both value and size. In the same vein, an equity fund with investments in startups with excellent prospects of growth can be said to be investing in small caps growth stocks, which also entails a combination of size and value.
- Money Market Funds
Money market mutual funds are made of riskless and safe short-term debt securities, such as government Treasury bills. This is where your money can be safely plunked for a short duration. The returns are not significant, but there is no risk of capital/principal loss. The returns are often slightly lower than certificate of deposit average earnings and higher than interest accrued on normal savings or checking account. Money market fund investments are usually ultra-safe, but it may sometimes deviate from this tendency as was observed during the financial crisis of 2008.
- Balanced Funds
The goal of balanced mutual funds is to offer an optimal combination of income, safety, and capital growth. Hence, the portfolio is typically made of equities as well as fixed income instruments. The weightage of any typical balanced mutual fund will usually be 35percent fixed income and 65 percent equity investments. Such weightage may also come with specified minimum and maximum restrictions for each class of asset; thus when the value of shares increase more than bond values, then the fund manager will rebalance it to 65/35 once again.
Asset allocation fund is a fund which is quite similar to balanced funds. The aims of this fund are the same as the objectives of a balanced mutual fund, but asset allocation funds usually do not come with restrictions on holding a certain amount of an asset class. The manager of such funds has the freedom to change the ratio of different classes of assets in the portfolio according to the changes in the business cycle and the economy.
- Short Bond Funds
Short Bond funds aggressively trade and invest in different kinds of bonds. They are usually managed actively and aim to purchase bonds that are comparatively undervalued so as to later sell them for profit. Bond funds typically yield higher returns as compared to money market securities and CDs, but they also carry risk. Since there are several kinds of bonds, short bond mutual funds may significantly differ from one another as per their area of investment. For instance, a bond fund with investments in government securities is a lot safer than a specialized fund which invests in high-yielding junk bonds. Also, almost all Short bond mutual funds are prone to the risk of interest rate, meaning that the fund value will reduce if interest rates increase.
- Income Funds
Income mutual funds gets its name from its objective, i.e., to offer steady current income on a regular basis. Such funds mainly invest in high-quality corporate debt and government instruments and hold them till maturity so as to offer interest inflows. The value of the holdings of the fund may appreciate during the period that the bonds are held, but the main aim of income funds is to offer steady influx of cash for investors.
- International/Global Funds
A foreign fund or an international mutual fund has investments just in assets that are located abroad or outside the borders of your home nation. The portfolio of global mutual funds however has investments all across the globe, including the home nation. Classifying such funds as being safer or riskier than investments in home country can be quite difficult.
Such funds do however come with distinctive political and foreign country risks and hence are prone to be relatively more volatile. On the other hand, inclusion of such funds into a well-balanced safe portfolio may actually help decrease risks by enhancing diversity of investments, and because yields in overseas nations may not be linked to yields at home. Even though the economies of the world are rapidly becoming more co-dependent and more co-related, there is always a chance that the economy of some other country is performing better than the home economy and thus investments there may provide better returns.
- Specialty Funds
Specialty funds are a category of mutual funds that are more of an all-including type and are made up of funds which have proven to be well-liked by investors, but may not fall under any of the well-defined mutual fund types presented above. Specialty funds avoid the rule of widespread diversification associated with mutual funds and instead focus on a targeted plan or a specific section of the economy.
- Sector funds can be termed as targeted plan funds with focus on particular economic sectors like technology, health, finance, etc. Hence these funds have a tendency to be extremely unpredictable since the shares in a specific sector usually have high co-relation with one another. There is a higher chance of huge profits or gains, but it is also possible for a sector to collapse, as was the case with the finance sector during the 2008/09 crisis.
- Socially-responsible funds, also known as ethical funds, have investments only in those companies that satisfy the requirements of certain beliefs or guidelines. For instance, certain ethical funds have no investments in ‘sin’ companies like alcohol, tobacco, etc. The basis of such funds is to get good yields while ensuring that a healthy conscience is retained. Other kinds of socially-responsible funds mainly invest in recycling, wind and solar power, and other such green technology companies.
- Exchange Traded Funds
ETFs or exchange traded funds are somewhat radically changed version of mutual funds. These funds are rapidly becoming popular with investors. ETF’s employ plans and gather investments in a manner that is just like mutual funds. However, they are prepared as investment trusts which can be traded, bought, and sold on stock exchanges, and also come with the extra advantage of the characteristics of stocks.
Exchange traded funds can be sold or purchased during any time of a business day, from the opening bell till the close. It can be bought on margin or sold short. As compared to a similar mutual fund, ETFs usually come with reduced fees. There are several ETFs that offer active options markets benefits where investors can leverage or hedge their spots. These funds also offer tax benefits from mutual funds. Exchange traded mutual funds are indeed very convenient and versatile and hence ever increasing in popularity.
- Index Funds
Index funds are mutual funds that are managed passively and which aim to duplicate the achievement of a broad market index like the Sensex S&P 500. Index funds are ideal for those investors who believe that the markets cannot be beaten on a regular basis by even the most active of fund managers. This type of mutual fund is designed to reproduce the market yields, thereby ensuring that investors gain in form of reduced fees.
- Fund of funds
Fund of funds seeks to invest in other mutual funds. They are similar to balanced mutual funds and seek to make diversification and allocation of assets a lot easier for investors. The MER or management expense ratio for this type of mutual fund is usually higher as compared to stand-alone funds.