What are the types of Equity Funds? 

Equity funds are one of the most popular types of mutual funds among investors. Owing to their high- return potential, many include it in their investment portfolio. However, there are various types of equity funds, based on their characteristics and risk-reward potential. By knowing the risk-reward potential, you can select the best equity funds to add to your portfolio. But before that, let's learn about equity funds.

What are equity funds?

An equity fund is a type of mutual fund where at least 65% of the fund's corpus is dedicated to equity and equity-oriented investments. The remaining corpus could be invested in debts and money market securities. This is usually done to increase liquidity and diversify the overall risk of the fund. Since equity funds are highly dependent on the stock market, they carry a higher risk possibility than debt funds or hybrid funds. However, in case of a bullish market, they are also capable of providing relatively higher returns than other mutual funds.

Equity mutual fund types can be classified as:

  • Market capitalisations
  • Investment strategies
  • Tax benefits

Equity Funds based on Market Capitalisation

  • Small-Cap Funds:

    Small-cap funds invest a majority (at least 65%) of their corpus into small-cap companies. The Securities and Exchange Board of India (SEBI) defines small-cap companies as those that fall below the 250th rank in a stock exchange as per their market capitalisation. In other words, they have a capitalisation of less than Rs. 500 crores.

    Since this fund invests majorly into small-cap companies, they carry high-risk, but also offer a higher upside potential. They may be preferable for aggressive risk-taking investors with a long investment horizon.

  • Mid Cap Funds:

    Mid-cap funds are those that allocate more than 65% of the fund's corpus into the equity of mid-cap companies. These are usually companies with a market capitalization ranging from Rs. 500 to 10,000 crores, and ranked from 101 to 250 in a stock exchange as per their market capitalization.

    These funds are known to offer good returns but are considered riskier than large-cap funds. They are usually regarded as suitable for longer investment horizons (7-10 years) and can be considered risky in the short-run.

  • Large Cap Funds:

    Large-cap funds invest majorly into large-cap companies. These are blue-chip companies that belong to the top 100 rankings of the stock exchange as per their market capitalisation. Since the companies have been steady for an extended period, the risk quotient involved with the investment is lower, but they also come with low return potential. Thus, these funds may be best for those looking to add stability and safety to their profile

  • Flexi-Cap/Multi-Cap/Diversified Funds:

    These funds invest across different market capitalisations: Since these funds invest across market capitalisation, they have exposure to large-cap, mid-cap, and small-cap stocks. It helps the investor to create a diversified portfolio with just a single fund.

    While they carry lesser risks than a pure mid-cap fund or a pure small-cap fund, they may be considered riskier than a pure large-cap fund. On the other hand, they have a slightly higher return potential than a large-cap fund owing to their exposure to mid-cap and small-cap companies. The Flexi-cap funds are for investors with moderate risk tolerance looking for potential long-term gain horizons.

Equity Funds based on Investment Strategies

  1. Sector Funds:

    These are equity funds that have maximum exposure to stocks of a particular sector such as pharma, banking, automobile, FMCG, etc. Through this fund, an investor can invest the corpus of the fund into companies belonging to a particular sector or industry that he may believe has excellent growth potential.

    Since these funds focus majorly on one sector, they carry a high-risk possibility with them but also come with high-return potential in case the sector performs well due to some favourable condition. These are usually for ultra-aggressive investors.

  2. Thematic Funds:

    While a sector fund invests majorly into one sector, a thematic fund invests across a few sectors based on a common theme. For instance, an infrastructure fund could invest across industries such as steel, power, real estate, cement, etc. They offer a slightly more diversified portfolio to the investor than the sector fund.

    While they too carry a very high-risk possibility, they are considered less risky than the sector funds due to the diversification it offers. These are best suited for aggressive and ultra-aggressive investors.

  3. Index Funds:

    These funds are made to mimic a pre-existing financial stock market index. The fund manager imitates the portfolio of the index it is following, to generate the same returns as an index. It comes under passive fund management, as the manager is not actively handpicking particular segments for investments of the corpus.

    Since they are passively managed funds and mimic an index, they are considered relatively less-risky. However, these funds can take a hit in the short run in case the market enters a bearish phase. As they mimic an index, they are for conservative investors with a long-term horizon.

  4. Focused funds:

    These funds limit the investments of the corpus by allowing the allocation of a fund to a maximum of 30 stocks. These funds aim to give more control to the investor. An investor can select a fund based on the equity that the fund can invest in.

    Since the fund focuses on only 20-30 stocks, it carries high risk but also comes with high return potential. This is suitable for aggressive investors that aim to gain more control over the fund by deciding on a fund based on the stocks it plans to invest in.

Equity Funds based on Tax Deduction

While all the different types of equity mutual funds enjoy tax benefits on long-term investments, one type comes with an added tax benefit.

Equity-Linked Savings Scheme (ELSS):

Equity-Linked Savings Scheme or ELSS, popularly known as tax saving mutual funds, these allow the investor to claim tax deductions on the invested amount in a financial year. This is apart from the tax benefits equity schemes enjoy on long- term capital appreciation.

You can claim tax deductions of up to INR Rs. 1.5 lakh, according to Section 80C of the Income Tax Act in a financial year by investing in these funds. However, these funds come with a mandatory lock- in period of 3 years. These are some of the most popular types of equity mutual funds.

Since most of these funds invest majorly into big companies, the risk level is low and comes with moderate return potential. Since these funds are relatively less risky and have an added tax benefit on investment, they are usually advised to new investors who are just starting their investment journey. This should be one of your first funds when building a portfolio