In this blog you are going to see different types of mutual fund available for us.
If you haven’t read the previous blog on this topic then please read it. Here’s the link
Investment in sector funds should be made when the fund manager expects the related sectors, to do well. They could out-perform the market, if the call on sector performance plays out. In case it doesn’t, such funds could underperform the broad market.
An open end sector fund should invest at least 80% of the total assets in the equity and equity-related instruments. XYZ Banking Fund, ABC Magnum Sector Funds are examples of sector funds.
Based on Themes
Theme-based funds invest in multiple sectors and stocks that form part of a theme. For example, if the theme is infrastructure then companies in the infrastructure sector, construction, cement, banking and logistics will all form part of the theme. It is eligible for inclusion in the portfolio. They have more diversification than sector funds but still have a high concentration risks.
An open-end thematic fund should invest at least 80% of the total assets in the equity and equity-related instruments of the identified sector. Under Thematic Category of mutual funds, any scheme under the ESG category can be launched with one of the following strategies –
a.Exclusion b.Integration c.Best-in-class & Positive Screening d.Impact investing e.Sustainable objectives f.Transition or transition related investments.
Based on Investment Style
The strategy adopted by the fund manager to create and manage the fund’s portfolio is a basis for categorizing funds. The investment style and strategy adopted can significantly impact the nature of risk and return in the portfolio. Passive fund invests only in the securities included in an index and does not feature selection risks. However, the returns from the fund will also be only in line with the market index.
On the other hand, active funds use selection and timing strategies to create portfolios that are expected to generate returns better than the market returns. The risk is higher too since the fund’s performance will be affected negatively if the selected stocks do not perform as expected.
The open-end equity funds (based on strategies and styles for selection of securities) are classified by SEBI as follows:
Value funds
Value Funds seek to identify companies that are trading at prices below their inherent value with the expectation of benefiting from an increase in price as the market recognizes the true value. Such funds have lower risk. They require a longer investment horizon for the strategy to play out. At least 65% of the total assets of the value fund should be invested in equity and equity-related instruments.
Contra fund
Contra Funds adopt a contrarian investment strategy. They seek to identify under-valued stocks and stocks that are under-performing due to transitory factors. The fund invests in such stocks at valuations that are seen as cheap relative to their long-term fundamental values. Mutual fund houses can either offer a contra fund or a value fund.
Dividend yield fund
Dividend yield funds invest in stocks that have a high dividend yield. These stocks pay a large portion of their profits as dividend and these appeals to investors looking for income from their equity investments. The companies typically have high level of stable earnings but do not have much potential for growth or expansion.
They therefore pay high dividends while the stock prices remain stable. The stocks are bought for their dividend pay-out rather than for the potential for capital appreciation. At least 65% of the total assets of the dividend yield fund should be invested in equity and equity-related instruments.
Focused fund
Focused funds hold a concentrated portfolio of securities. SEBI’s regulation limits the number of stocks in the portfolio to 30. The risk in such funds may be higher because the extent of diversification in the portfolio is lower.
Debt Funds
It invest in a portfolio of debt instruments such as government bonds, corporate bonds and money market securities. Debt instruments have a pre-defined coupon or income stream. Bonds issued by the government have no risk of default and thus pay the lowest coupon income relative to other bonds of same tenor. These bonds are also the most liquid in the debt markets.
Corporate Bonds
Corporate bonds carry a credit risk or risk of default and pay a higher coupon to compensate for this risk. Fund managers have to manage credit risk, i.e. the risk of default by the issuers of the debt instrument in paying the periodic interest or repayment of principal. The credit rating of the instrument is used to assess the credit risk and higher the credit rating, lower is the perceived risk of default. Government and corporate borrowers raise funds by issuing short and long-term securities depending upon their need for funds.
Debt instruments may also see a change in prices or values in response to changes in interest rates in the market. The degree of change depends upon features of the instrument such as its tenor and instruments with longer tenor exhibit a higher sensitivity to interest rate changes
Fund managers make choices on higher credit risk for higher coupon income and higher interest rate risk for higher capital gains depending upon the nature of the fund and their evaluation of the issuer and macro-economic factors.
Debt category of funds
Debt funds can be categorized based on the type of securities they hold in the portfolio, in terms of tenor and credit risk.
Short Term Debt Funds aim to provide superior liquidity and safety of the principal amount in the investments. It does this by keeping interest rate and credit risk low by investing in very liquid, short maturity fixed income securities of highest credit quality. The objective is to generate a steady return, mostly coming from accrual of interest income, with minimal NAV volatility.
The open-end debt schemes (investing in securities with maturity ranging from one day to one year) are classified by SEBI as follows:
Overnight Funds
It invest in securities with a maturity of one day.
Liquid Funds
It invest in debt securities with less than 91 days to maturity.
Ultra Short Duration Funds
It invest in debt and money market instruments such that the Macaulay duration of the portfolio is between 3 months and 6 months.
Low Duration Fund
It invest in debt and money markets instruments such that the Macaulay duration of the fund is between 6 months to 12 months.
Money Market Fund
It invest in money market instruments having maturity up to one year.
The next category of debt funds combines short term debt securities with a small allocation to longer term debt securities. Short term plans earn interest from short term securities and interest and capital gains from long term securities. Fund managers take a call on the exposure to long term securities based on their view for interest rate movements. If interest rates are expected to go down, these funds increase their exposure to long term securities to benefit from the resultant increase in prices. The volatility in returns will depend upon the extent of long-term debt securities in the portfolio.
Short term funds may provide a higher level of return than liquid funds and ultra-short term funds, but will be exposed to higher mark to market risks.
Open-end debt schemes investing in the above stated manner are categorised by SEBI in the following manner:
Short duration funds invest in debt and money market instruments such that the Macaulay duration of the fund is between 1 year – 3 years.
Medium duration fund invests in debt and money market instruments such that the Macaulay duration of the fund is between 3 years- 4 years.
Medium to Long duration fund invests in debt and money market instruments such that the Macaulay duration of the fund is between 4 years- 7 years. If the fund manager has a view on interest rates in the event of anticipated adverse situations then the portfolio’s Macaulay duration may be reduced to one year for Medium and Medium to Long duration funds.
Corporate bond fund
Corporate bond fund invests at least 80% of total assets in corporate debt instruments with rating of AA+ and above. Credit Risk Funds invest a minimum of 65% of total assets in corporate debt instruments rated AA and below. Banking and PSU fund invests a minimum of 80% of total assets in debt instruments of banks, Public Financial Institutions and Public Sector Undertakings and municipal bonds.
Open-end gilt funds
It invest at least 80% of the total assets in government securities across maturities. There is no risk of default and liquidity is considerably higher in case of government securities. However, prices of government securities are very sensitive to interest rate changes.
Long term gilt funds
It have a longer maturity and therefore, higher interest rate risk as compared to short term gilt funds.
Gilt funds
These are popular with investors mandated to invest in G-secs such as provident funds or PF trusts. Gilt fund with 10 year constant duration invest a minimum of 80% of total assets in government securities such that the Macaulay duration of the portfolio is equal to 10 years.
Dynamic bond funds
These seek flexible and dynamic management of interest rate risk and credit risk. That is, these funds have no restrictions with respect to security types or maturity profiles that they invest in. Dynamic or flexible debt funds do not focus on long or short term segment of the yield curve, but move across the yield curve depending on where they see the opportunity for exploiting changes in yields duration of these portfolios are not fixed, but are dynamically managed. If the manager believes that interest rates could move up, the duration of the portfolio is reduced and vice versa.
Fixed maturity plans (FMPs) are closed-end funds that invest in debt securities with maturities that match the term of the scheme. The debt securities are redeemed on maturity and paid to investors. FMPs are issued for various maturity periods ranging from 3 months to 5 years.
Hybrid Funds
Hybrid funds invest in a combination of debt and equity securities. The allocation to each of these asset classes will depend upon the investment objective of the scheme. The risk and return in the scheme will depend upon the allocation to equity and debt and how they are managed. A higher allocation to equity instruments will increase the risk and the expected returns from the portfolio. Similarly, if the debt instruments held are short term in nature for generating income, then the extent of risk is lower than if the portfolio holds long-term debt instruments that show greater volatility in prices. SEBI has classified open-end hybrid funds as follows:
Conservative hybrid fund
Conservative hybrid funds invest minimum of 75% to 90% in a debt portfolio and 10% to 25% of total assets in equity and equity-related instruments. The debt component is conservatively managed with the focus on generating regular income, which is generally paid out in the form of periodic dividend. The credit risk and interest rate risk are taken care of by investing into liquid, high credit rated and short term debt securities.
The allocation to equity is kept low and primarily in large cap stocks, to enable a small increase in return, without the high risk of fluctuation in NAV. These attributes largely contribute accrual income in order to provide regular dividends.
Debt oriented hybrid fund
Debt-oriented hybrid fund are designed to be a low risk product for an investor. These products are suitable for traditional debt investors, who are looking for an opportunity to participate in equity markets on a conservative basis with limited equity exposure. These funds are taxed as debt funds.
Balanced hybrid fund
Balanced Hybrid Fund invests 40% to 60% of the total assets in debt instruments and 40% to 60% in equity and equity related investments.
Aggressive hybrid fund
Aggressive Hybrid Funds are predominantly equity-oriented funds investing between 65% and 80% in the equity market, and invest between 20% up to 35% in debt, so that some income is also generated and there is stability to the returns from the fund.
Mutual funds are permitted to offer either an Aggressive Hybrid fund or Balanced Hybrid fund.
Dynamic Asset Allocation or Balanced Advantage fund dynamically manage investment in equity and debt instruments
Multi Asset Allocation Funds invest in at least three asset classes with a minimum of 10% of the total assets invested in each of the asset classes. The fund manager takes a view on which type of investment is expected to do well and will tilt the allocation towards either asset class. Within this, foreign securities will not be treated as separate asset class.
Arbitrage fund
Arbitrage funds aim at taking advantage of the price differential between the cash and the derivatives markets. It is simultaneous purchase and sale of an asset to take advantage of difference in prices in different markets. The difference between the future and the spot price of the same underlying is an interest element. It representing the interest on the amount invested in spot. It can be realized on a future date, when the future is sold. Funds buy in the spot market and sell in the derivatives market, to earn the interest rate differential.
For example, funds may buy equity shares in the cash market at Rs. 80 and simultaneously sell in the futures market at Rs.100, to make a gain of Rs. 20. If the interest rate differential is higher than the cost of borrowing there is a profit.
Thanks for reading. This blog is big but it’s really vast topic.
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