Mutual fund industry offers a long menu of schemes with different investment objectives and as such risk/returns. An investors has a full choice to select the scheme as per his taste preference. Different types of mutual funds are list below.
Gilt funds invest in only treasury bills and government securities, which do not have a credit risk (i.e. the risk that the issuer of the security defaults).
Diversified debt funds invests in a mix of government and non-government debt securities.
Junk bond schemes or high yield bond schemes invest in companies that are of poor credit quality. Such schemes operate on the premise that the attractive returns offered by the investee companies makes up for the losses arising out of a few companies defaulting.
Fixed maturity plans 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. Further, like close-ended schemes, they do not accept moneys post-NFO. Thanks to these characteristics, the fund manager has little ongoing role in deciding on the investment options. 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.
Floating rate funds invest largely in floating rate debt securities i.e. debt securities where the interest rate payable by the issuer changes in line with the market. For example, a debt security where interest payable is described as ‘5-year Government Security yield plus 1%’, will pay interest rate of 7%, when the 5-year Government Security yield is 6%; if 5-year Government Security yield goes down to 3%, then only 4% interest will be payable on that debt security. The NAVs of such schemes fluctuate lesser than debt funds that invest more in debt securities offering a fixed rate of interest.
Liquid schemes or money market schemes are a variant of debt schemes that invest only in debt securities where the moneys will be repaid within 91-days. As will be seen later in this Work Book, these are widely recognized to be the lowest in risk among all kinds of mutual fund schemes.
Diversified equity fund is a category of funds that invest in a diverse mix of securities that cut across sectors.
Sector funds however invest in only a specific sector. For example, a banking sector fund will invest in only shares of banking companies. Infra sector fund will invest in only shares of
infrastructure 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, 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), as seen earlier, offer tax benefits to investors. However, the investor is expected to retain the Units for at least 3 years.
Equity Income / Dividend Yield Schemes invest in securities whose shares fluctuate less, and therefore, dividend represents a larger proportion of the returns on those shares. The NAV of such equity schemes are expected to fluctuate lesser than other categories of equity schemes.
Arbitrage Funds take contrary positions in different markets / securities, such that the risk is neutralized, but a return is earned. For instance, by buying a share in BSE, and simultaneously selling the same share in the NSE at a higher price. Most arbitrage funds take contrary positions between the equity market and the futures and options market..
Monthly Income Plan seeks to declare a dividend every month. It therefore invests largely in debt securities. However, a small percentage is invested in equity shares to improve the scheme’s yield. The term ‘Monthly Income’ is a bit of a misnomer, and investor needs to study the scheme properly, before presuming that an income will be received every month.
Capital Protected Schemes are close-ended schemes, which are structured to ensure that investors get their principal back, irrespective of what happens to the market. This is ideally done by investing in Zero Coupon Government Securities whose maturity is aligned to the scheme’s maturity. (Zero coupon securities are securities that do not pay a regular interest, but accumulate the interest, and pay it along with the principal when the security matures). Some of these schemes are structured with a minor difference – 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, it would be appropriate to view these alternate structures as Capital Protection Oriented Schemes rather than Capital Protected Schemes. It may be noted that capital protection can also be offered through a guarantee from a guarantor, who has the financial strength to offer the guarantee. Such schemes are however not prevalent in the market.
Gold Sector Funds i.e. the fund will 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. (Gold Sector Fund is like any equity sector fund, which was discussed under ‘Types of Equity Funds’. It is discussed here to highlight the difference from a Gold ETF)
Real Estate Funds
They take exposure to real estate. Such funds make it possible for small investors to take exposure to real estate as an asset class. Although permitted by law, real estate mutual funds are yet to hit the market in India.
These are funds that invest outside the country. For instance, a mutual fund may offer a scheme to investors in India, with an investment objective to invest abroad. As such investor through this scheme may take advantage of booming markets abroad when domestic markets are lack lusture.
Fund of Funds
A mutual fund that invests in other mutual funds are called fund of funds. These ‘fund of funds’ pre-specify the mutual funds whose schemes they will buy and / or the kind of schemes they will invest in. They are designed to help investors get over the trouble of choosing between multiple schemes and their variants in the market. Thus, an investor invests in a fund of funds, which in turn will manage the investments in various schemes and options in the market.
Exchange Traded Funds
Exchange Traded funds (ETF) are open-ended index or commodity funds that are traded in a stock exchange. A feature of open-ended funds, which allows investors to buy and sell units from the mutual fund, is made available only to very large investors in an ETF. Other investors will have to buy and sell units of the ETF in the stock exchange. In order to facilitate such transactions in the stock market, the mutual fund appoints some intermediaries as market makers, whose job is to offer a price quote for buying and selling units at all times. If more investors in the stock exchange want to buy units of the ETF, then their moneys would be due to the market maker. The market maker would use the moneys to buy a basket of securities that is in line with the investment objective of the scheme, and exchange the same for chapters of the scheme from the mutual fund. A key benefit of an ETF is that investors can buy and sell their units in the stock exchange, at various prices during the day that closely track the market at that time. Further, the unique structure of ETFs, make them more cost-effective than normal index funds, although the investor would bear a brokerage cost when he transacts with the market maker.