WHAT IS GROWTH FUND: DEFINITION, FEATURES AND MORE?
Normally, growth investing and value investing are seen as two opposite sides of investment strategy, although it may not always be true. Here is a quick difference between a growth investing approach and a value investing approach. Growth funds are normally the diversified equity funds that are in contrast to the value funds. These growth funds typically identify stocks that have high growth potential even if the stock prices and the valuations are relatively steep. The assumption is that the growth in earnings and revenues can more than make up for the relatively higher valuations of these stocks.
Are growth fund riskier than value funds? There are not hard and fast answers to this question. What we can infer is that growth stocks tend to be better bets in the short to medium term but don’t give multi-bagger returns in the long run. However, value stocks may not really flatter in the short to medium term but if identified with appropriate strategy and effort, it has the potential to create multi-baggers over the long run i.e. a holding period of more than 5-7 years.
Growth funds versus growth options
Investors often get confused between a growth option of a mutual fund and a growth fund. Here are some basic differences between the two.
- A growth fund is a mutual fund that invests in high growth stocks. These fund are not too perturbed by the higher P/E ratios but prefer the stocks that have momentum and high growth potential in their favour. Growth funds, tend to outperform value funds in the short to medium term.
- Growth option is an option within a mutual fund, wherein the dividends are not distributed by the fund. Instead, the fund reinvests any profits in the same fund so that the benefits of reinvestment and compounding are available to the investors. Growth funds normally suggest growth option as it is a better value compounder and also more tax efficient.
Concept of Growth Fund 101
Till now we have laterally discussed the concept of growth fund quite elaborately. Let us now look at the definition of a growth fund from the mutual fund investor perspective. Growth funds typically invest in the stocks of companies which offer promising returns due to being in a high growth industry and having delivered high growth in the past. Investors invest in the fund with the only goal of achieving capital appreciation.
Relative to value funds, the risk element is lower in growth funds as growth and momentum is in favour of these funds in the short to medium term. Along with high returns, the risks are fairly high, although it is lower than a value fund. While investing, the growth funds typically eliminate stocks of companies that have high dividend pay-out ratios. They prefer stocks that reinvest most of the profit within the company. Growth funds normally experience high returns when the market is bullish but underperform in bearish markets.
HIGHGLIGHTS OF GROWTH FUNDS
Here are some of the key features pertaining to growth funds.
- Firstly, let us look at how growth funds are placed on the risk scale. The fund is highly risky, and it is only suitable for investors who have a high-risk appetite. However, once you invest in it, the returns are promising in the short to medium term.
- Volatility is part and parcel of a growth funds. If you are investing in growth funds, you should be ready to face market volatility. Stocks tend to rise and drop as they are market-linked financial instruments. These growth stocks are most vulnerable.
- In the short to medium term, growth stocks tend to display potential of index beating returns. Investors find this feature of growth stocks especially attractive. That is why this growth funds essentially attracts the attention of investors. High returns are a norm in the short to medium considering that stocks are hand-picked by top fund managers.
- When handling volatile assets, it is expertise that matters. That is where growth funds make a difference. Selection of growth stocks entails precision and expertise. Fund managers are also responsible for buying and selling decisions.
- Normally, growth funds have a substantially diversified portfolio and comprises of a mix of stocks of fast-paced companies. This provides sectoral and thematic diversification to the investors. This helps to reduce volatility to some extent.
- Growth fund need commitment of at least 3 to 5 years to be really able to make returns amidst the volatility in the markets. It may not take as much as time value stocks to give returns, but it is long term nevertheless.
- Growth funds normally adopt the growth option in mutual funds. This makes them auto compounders as the profits in equity investing are automatically reinvested in the same portfolio. This ensure that power compounding works best over the medium term, rather than impairing wealth creation by paying out dividends.
WHAT TYPE OF INVESTORS ARE GROWTH FUND BEST SUITED FOR?
These are the investors best suited to invest in growth funds.
- Growth funds are best suited to risk-embracing and aggressive investors who are looking to outperform the stock market index returns.
- Growth funds are best suited to investors with a long-term investment horizon of at least 4-5 years so that the volatility is evened out.
- This fund is not ideal for those who are at a conservative investment stage. For instance, individuals who are close to their retirement age or who are having too many liabilities, are not suited to investing monies in growth funds.
- Growth funds are suited to a young investor with age on their side. This is ideal for investors with a long-term commitment and having surplus money with the risk appetite including substantial erosion of capital in bear markets.
In short, growth funds are a high risk option although they can give returns like high beta stocks. But they also carry the risk of high beta stocks in that they can underperform the market during bear market conditions. This makes the growth fund intrinsically volatile and best suited to investors with a higher risk appetite, longer staying power and the ability to take losses in their stride.
How are growth funds taxed?
The table below captures the gist of how growth funds are taxed. Since growth funds are essentially equity funds, they will be taxed as equity funds. Here is the tax treatment of growth funds.
|Taxation Point||Growth Mutual Funds|
|Classification of LTCG||They are classified as equity funds so more than 1 year holding becomes LTCG and less than 1 year is STCG|
|Taxation of LTCG (Long term capital gains)||Since they are classified as equity, LTCG is tax free up to Rs.1 lakh per annum. Above that it is taxed at 10% flat, without indexation benefit.|
|Taxation of STCG (Short term capital gains)||Since they are classified as equity, STCG is taxable at a concessional rate of 15% on the gains made|
In addition to the above, short term losses on growth funds can be set off against short term gains and long term gains. However, long term losses can only be set off against long term gains. Such losses, if unabsorbed, can also be carried forward for a period of 8 assessment years.