What is Mutual Fund? Meaning, All About Mutual Funds

Classification on the basis of fund structure:

This type of classification depends on the flexibility to sell and purchase individual mutual fund units.

Open-ended: This type of mutual fund investment offers the highest flexibility in terms of the unit purchased or tenure. Open-ended mutual funds do not come with any specific constraint in terms of the quantity of units purchased or investment tenure. Investor has the liberty to trade however they want to and exit whenever they want to at the current Net Asset Value (NAV).

Close-ended: In this type of mutual fund investment, the unit capital is fixed. In other words, the mutual fund company is restricted when it comes to selling more than the pre-decided limit. In addition, it has a fixed maturity date; an investor cannot withdraw from the fund before the maturity date.

Interval Funds: As the name suggests, interval funds allow trading of the units during pre-decided transaction intervals. As per the rules of the scheme, the transaction period has to be at least 2 days, with a 15-day window between the two transactions.

Classification on the Basis of Investment Objective

Growth Funds:

This type of mutual fund invests in growth-oriented funds such as equity for capital appreciation. Growth funds are preferred by investors who have surplus sums that they can invest in high-risk instruments to gain high returns. In addition, they should be willing to have a medium or long investment horizon.

This type of mutual fund invests money in multiple debt assets such as certificates of deposits, bonds, and securities. Regular income funds have had a reputation for earning higher returns as compared to deposits. They offer a steady and regular income to investors. However, there is zero guarantee of returns as they depend on the performance of funds. The return is generated from the interest income and capital gains resulting from any fluctuations in the value of securities. As this mutual fund invests in debt mutual funds, it is ideal for risk-conservative investors who can invest for 2-3 years.

Liquid funds are a sub-category of debt funds as they majorly invest in debt instruments for up to 91 days. This type of mutual fund comes with a maximum investment limit of 10 lakh. What makes liquid funds different from other debt funds is the calculation of Net Asset Value. The NAV is calculated for 365 days, while for others, only business days are accounted. The returns depend on the current short-term interest rate. Ideal for investors with a short investment horizon.

Classification on the Basis of Asset Class:

Mutual funds also differ on the basis of asset classes. Let us understand the bifurcation.

Equity Mutual Funds:

As the name suggests, equity mutual funds invest in stock or equity. As the investment is market-linked, the returns depend on the performance of shares in the market. These funds are known to generate high returns, but at the same time, they carry high risk.

Large-cap funds invest in large-capitalisation companies. These funds have the reputation of generating stable returns. They are also considered the safest when compared to all equity funds. Owing to the stock's reliability and good name, they are chosen by investors even during shaky market conditions. Large-cap funds do carry market risk, but this risk seldom takes a sudden plunge as the risk is diluted when other stocks perform well, even when one or two fail.

As the name suggests, mid-cap funds invest in companies with moderate capital. The 65% allocation and distribution of funds is made in equity and equity-linked instruments of mid-cap companies. These companies are in their growth phase and looking to expand in the future. Consequently, mid-cap mutual funds happen to be more aggressive than large-cap mutual funds. Even though these funds offer high returns, they carry a high level of risk as compared to large-cap funds.

Small-cap Funds:

This type of mutual fund invests in equity schemes of small capitalisation companies. This fund invests a minimum of 65% in equity and equity-related schemes of small-cap companies. Small-cap companies have a very high growth potential if everything goes right. As growth isn't guaranteed, it carries the highest risk but the highest returns.

An Equity Linked Saving Scheme, also known as ELSS, is one of the most preferred tax-saving instruments in the market. Not only do they help investors save on tax, but they also facilitate wealth creation. In addition, they come with a short lock-in period of 3 years. This type of mutual fund is appropriate for salaried individuals.

Flexi-cap funds invest in equity and equity-related financial assets across all market capitalisations – small, mid, and large-cap. Providing both value and growth to investors, these mutual funds are dynamic enough to strike a balance between returns and risk by shifting among them. These funds are not limited to investing in stocks with pre-decided capitalization. The fund is allocated to different capitalizations to mitigate the risks by reducing the volatility of a particular capital market.

Thematic funds are inclined towards specific themes or trends, such as sustainability and clean energy, and therefore invest in companies matching the specific theme.

Multi-cap mutual funds do not concentrate on a single market capitalisation but expand to all capitalisations and sectors. The investment in the fund assets is exposed to large-cap stocks to maintain stability and mid-cap and small-cap to yield growth potential. The underlying stocks can redeem their value in the bull market, where the manager capitalizes on the growth opportunities of both small and medium companies. Similarly, they bend towards large-cap stocks to take refuge when the market gets bearish.

This type of mutual fund adheres to a value investment strategy. They invest in stocks of companies that have 'value' and the potential to grow in the future. These are the companies that have an underrated stock value, and stock value is not a faithful indicator of their worth. A company’s intrinsic value is determined by considering its business model, financials, competitive analysis, and management team, to name a few. If the company’s intrinsic value is more than the market value, it is regarded to have 'value.'

Contra Funds:

Contra funds are an open-ended scheme with a unique investment principle. This type of mutual fund makes investments based on converse investment sentiments prevalent in the market. This means stocks of a company are purchased even when they are not performing well. Both under-performance and over-performance of stocks result in the distorted value of the asset, which the fund manager attempts to capitalize on. The core ideology behind this is that the low price of an asset would normalize in the long run. This type of mutual fund helps investors take advantage of the contrarian theory by generating returns from fluctuating market conditions. 65% of the investment is made into equity and related funds.

This type of mutual fund invests in stocks of companies that have a good record of distributing high dividends to the shareholders when the profit is high. It is important to note that these companies only allocate dividends when they earn profits. Ergo, a dividend yield fund, invests in highly profitable companies with a good reputation for allocating dividends.

A focused mutual fund holds a small variety of bonds and stocks that share a similarity. They can be focused on a limited number of stocks belonging to a limited number of sectors instead of holding a diversified combination. These funds hold positions in 20-30 companies or less, in contrast to funds that hold positions in more than 100 companies.

This type of mutual fund can invest in internationally located companies. These funds can help investors broaden their investment options, resulting in higher return potentials.

An index fund monitors the performance of an underlying index, like the Sensex or Nifty. These funds adhere to their benchmark index unaffected by market conditions. These funds provide diversified exposure with lower management costs. Since Index Funds replicate the performance of the indices as a whole, they are considered to be suitable as only long-term investments.

An Exchange Traded Fund, also known as ETF, can be traded on a stock exchange. ETFs are designed to monitor the performance of a particular index or a group of assets, such as stocks, bonds, or commodities. By investing in an ETF, an individual can gain exposure to a diverse range of assets without having to buy each asset individually. ETFs offer several benefits, including low costs, tax efficiency, and ease of trading. They have become increasingly popular lately as a method for investors to gain diversified exposure to various markets and sectors.

Debt Mutual Funds:

Debt fund is a type of investment fund that chiefly invests in fixed-income securities, such as bonds, treasury bills, and corporate debt. The main objective of debt mutual funds is to generate income for investors through interest payments on the underlying securities. These funds are typically less volatile than equity mutual funds, making them a popular choice for investors who seek stable returns and have a lower risk appetite.

Liquid funds are a kind of debt mutual fund that invests in short-term money markets instruments such as treasury bills, commercial papers, and certificates of deposit. These funds are known for their high liquidity and low-risk profile, making them a popular investment option for those looking to park their idle money for a short period of time. They are regarded as a safe investment option available, with the potential to generate higher returns than traditional savings accounts or fixed deposits. These funds typically have no exit load or lock-in period, making them a flexible option for investors who need quick access to their funds.

Overnight funds are a type of debt mutual fund that primarily invests in overnight securities, such as repo and reverse repo agreements, treasury bills, and cash reserves. As the name suggests, these funds typically have a noticeably short investment horizon of one day, making them one of the most secure investment options available in the market. In addition, they are regarded to be one of the most liquid investment options, with low volatility and no credit risk. They offer a higher rate of return than traditional savings accounts and are an ideal option for those looking to park their idle funds for a brief period of time. Additionally, overnight funds have no exit load or lock-in period, making them a highly flexible investment option.

Ultra-Short Duration Funds invest in fixed-income securities with a maturity period of 3 to 6 months. These funds are ideal for investors who seek a slightly higher return than traditional liquid funds without taking on too much risk. Ultra-Short Duration Funds typically invest in a mix of high-quality debt securities, including government securities, certificates of deposit, and corporate bonds. They are designed to provide stable returns over a short-term investment horizon and are less volatile than longer-term debt mutual funds. These funds also offer the benefit of lower credit risk and high liquidity. Ultra-Short Duration Funds may be suitable for investors with a low-to-medium risk profile who are looking for a flexible investment option with higher returns than savings accounts or fixed deposits.

Low Duration Funds:

Low Duration Funds are a type of debt mutual fund that primarily invests in fixed-income securities with a maturity period of 6 to 12 months. They are ideal for investors who seek slightly higher returns than traditional liquid funds or ultra-short duration funds, with lower risk. Low-duration funds typically invest in a mix of high-quality debt securities, including government securities, corporate bonds, and money market instruments. These funds are designed to provide stable returns over a short-term investment horizon and are less volatile than long-term debt funds. Additionally, low-duration funds have the benefit of lower credit risk and high liquidity. Low-duration funds may be suitable for investors with a low-to-medium risk profile who are looking for a flexible investment option with higher returns than savings accounts or fixed deposits.

Medium Duration Funds are a type of debt mutual fund that primarily invests in fixed-income securities with a maturity period of 3 to 4 years. These funds aim to offer a balance between the stability of low-duration funds and the potential for higher returns of long-duration funds. According to experts, these funds are best suited for investors with a medium to high-risk appetite and a longer investment horizon of up to 4 years.

Medium Duration Funds typically invest in a mix of high-quality debt securities, including government securities, corporate bonds, and money market instruments. These funds may provide higher returns than low-duration funds and ultra-short-duration funds, but they also come with a higher level of risk. It is important to understand the investment strategy and risk profile of medium-duration funds before investing.

Medium to Long Duration Funds is a type of debt mutual fund that primarily invests in fixed-income securities with a maturity period of 4 to 7 years. These funds aim to provide a balance between the stability of low-duration funds and the potential for higher returns of long-duration funds. According to experts, these funds are best suited for investors with a medium to high-risk appetite and a longer investment horizon of 5 years or more.

Medium to Long Duration Funds typically invests in a mix of high-quality debt securities, including government securities, corporate bonds, and money market instruments. These funds may provide higher returns than low-duration funds and medium-duration funds, but they also come with a higher level of risk. It is important to understand the investment strategy and risk profile of medium to long-duration funds before investing.

International & Domestic Fund of Funds (FoFs):

International and Domestic Fund of Funds are mutual funds that invest in a combination of various mutual funds. International Fund of Funds invests in foreign mutual funds that invest in stocks, bonds, and other securities outside of the investor's home country. Domestic Fund of Funds, on the other hand, invest in a combination of mutual funds within the investor's home country.

This type of hybrid mutual fund helps an investor to save for their child's future. Children’s mutual funds often known as Gift schemes typically have a lock-in period of 5 years and can be redeemed in the long-term to pay for planned expenses like children’s education expenses, marriage, etc.

This type of mutual fund is an open-ended scheme with an initial lock-in period of 5 years that helps investors in retirement planning for the long-term. This type of fund invests in low-risk investments such as government securities to provide a steady income to the individual. However, a retirement mutual fund also invests in equity and debt securities to gain returns and ensure your investment grows.

•  Affordable and Convenient: What makes mutual benefits the best investment option is the flexibility and affordability of the mutual funds. For many investors, it is non-affordable to purchase all units of a single mutual fund. Some investors may be new to the concept of mutual funds and try it for the first time. Such investors can start by investing a smaller amount. If you are a working professional, you can invest through Systematic Investment Plan (SIP). With an SIP, you can invest money monthly or quarterly as per your budget or convenience and you can also estimate your future investment corpus using a SIP calculator.
•  Liquidity: One of the significant benefits of investing in mutual funds is the 'liquidity' of the funds. This liquidity feature applies to the units of open-ended mutual funds. An investor can liquidate (redeem) the units to fulfil your financial needs at any time on any business day (opening days of the stock market or banks). After liquidating your units, the amount is credited to your account within 2-4 days, depending on the scheme of your mutual funds.
•  Professional Management: Some investors may be a new mutual fund investor or may not have the required knowledge or enough time to research different mutual fund schemes and purchase stocks. Mutual funds are managed by professionals with experience and expertise in actively buying, selling, and monitoring investments. Professional portfolio management is the most significant benefit of investing in mutual funds. The experts timely inspect the investments and rebalance the portfolio accordingly to meet the scheme's objective.
•  Low Cost: Another beneficial point of mutual funds is their low cost. As a result of higher economies of scale, mutual fund schemes have a low expense ratio. The expense ratio is the per unit cost required for running and managing a mutual fund. The lower the expense rate, the higher the returns on investment.

• 5. Risk Diversification: The value of investments is changeable and may rise or fall. Investing in mutual funds is beneficial as you can simultaneously invest in multiple asset categories to reduce the risk. By diversifying your investment, the threats cognate with one asset can be countered by the others.
• 6. Tax Benefit: Under sector 80C of the Income Tax Act, investments in ELSS (Equity Linked Savings Scheme) offer an accumulated tax exemption of up to ₹1.5 lacs in the three-year lock-in tenure of the scheme. Additionally, the taxation rules of mutual fundsin India focus primarily on the gains from investment and not on the income tax slab of the investor.