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What Are Equity-Oriented Mutual Funds and How Do They Work?

Equity-oriented mutual funds come with higher return potential although they also carry a certain amount of risks. This post will help you understand what these funds are and how they work.

Getting Started with Equity Oriented Mutual Funds

Mutual funds are those that pool money from investors and invests the corpus of the fund into various capital assets, such as debt, foreign securities, equities, gold, etc. They are primarily of three types- Equity, Debt and Hybrid Funds.

Equity mutual funds are those where the predominant percentage of the corpus of the collected fund is invested in equity shares of companies.

How do Equity Oriented Funds Work?

Equity Funds invest at least 65% of their corpus into equities or equity-oriented investments. The remainder of the corpus could be invested in debts or money market securities. Simplistically put, it works in a manner of give-and-take. You give your money to an equity fund, and the fund invests it into stocks or equities of companies. You are entitled to the gains or losses through these stocks. However, since the funds are managed by professionals, over a period of time, profits from investments tend to outweigh the losses made.

Asset Allocation

While many equity funds are allocated to equity-related investments entirely, many equity funds are also divided in a way where at least the majority (65%) of the fund is invested into equities, and the remaining into debts or market securities. This may be done to ensure the liquidity of the fund and keep it safer from market risks.

Who is the Fund For?

An Equity Fund is for anyone willing to take a moderate amount of risk for long term growth horizons. Since equity funds invest majorly into equity, they carry with them market risks. However, this also gives them the potential to generate good returns for investors. It is also for people who want to rely solely on a fund manager to stay in charge of their investments and escape the hassle of having to do it themselves.

What are the Characteristics of Equity Oriented Mutual Funds?

  1. Expenses:

    The fund manager plays a vital role in equity fund management, and hence charges a good fee for it. The SEBI (Securities and Exchange Board of India) has specified the expense ratio shouldn't exceed 2.5% for equity funds. Some equity funds, like the flex-cap funds, incur other transaction costs that are not included in the expense ratios. The lower the expense ratio, the higher the net rate of return for the investor.

  2. Holding Period:

    All capital gains from investments to the fund are taxable in the investor's hands. The amount of time an investor has stayed invested in a fund decides the taxation rate that would be incurred to them. This period of time is known as the holding period. Holdings that last less than a year are considered short-term investments, whereas those that last longer than a year are considered as long-term investments

  3. Fund Management:

    The investors leave the management of the fund in the hands of a trustworthy and reliable fund manager, who creates a strategy of investments and formulates the portfolio of the fund. For actively managed funds, he is in charge of all the capital assets the fund will buy with its corpus. The manager must remain deft in cases of market crashes or steep market changes. If fund management firms work with multiple investors, they gain experience and are able to formulate diversified portfolios for the investors.

  4. Diversification:

    Equity funds offer a high range of diversity in terms of risk quotients and investment strategies. There are various kinds of equity funds that are divided based on market

  5. Taxations of Equity Funds:

    The taxation of equity funds, as mentioned above, depends upon the holding period of the fund.

    1. The LTCG (Long Term Capital Gains) tax is applicable to all kinds of equity funds at the rate of 10% plus a 4% cess if the holding period lasts longer than a year and the gains exceed INR Rs.1Lakh for that year. This is more advantageous than other mutual funds, as they have a lesser holding period of just one year for it to be considered a long-term capital gains. Debt funds have to be held for 36 months for the gains to be considered long-term.

    2. STCG (Short Term Capital Gains) tax of 15% with a 4% cess is accrued to the capital gains for holding periods lasting less than a single year. It is notable that tax incidents only arise if the units of a mutual fund scheme are sold. However, for ELSS or tax-saving funds, the investors can claim tax deductions of up to INR Rs.1.5 Lakh in exchange for a lock-in period of investment of 3 years. Dividends are not taxable in the hands of the investor, but the AMC incurs a dividend distribution tax (DDT) at the rate of 11.648%.

  6. Plans for Equity Funds:

    Redistribution of returns obtained from any mutual fund scheme is available in two types of plans- growth and dividend.

    1. The growth plan allows the fund manager to invest the dividend payments into more securities. This allows them to grow their money ultimately.

    2. The dividend plan allows the fund manager to use the dividends attained to purchase more shares for the fund.

If the investors realise a good capital gain from the said of their units in the fund, a dividend option is advisable as it would increase the number of units in the fund leading to more profitable returns in the future. Most fund management companies don't charge extra rates to reinvest your dividends. Reinvestment is not a good option if you are looking to receive periodic returns in your investments.

Based on all of the above characteristics, equity funds are available in various types, as mentioned below.

Types of Equity Funds

Equity funds all have a different underlying portfolio and market risk quotient attached to them. Here is a guide to the different kinds of equity funds available in India.

  1. Small-Cap Funds:

    These funds invest a majority (at least 65%) of their corpus into small-cap companies.

  2. 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.

  3. Large Cap Funds:

    Large-cap funds invest majorly into companies with larger market capitalisations.

  4. Flexi-Cap/ Multi-Cap/ Diversified Funds:

    These funds invest a majority of its corpus across diversified sectors and market capitalisations.

  5. Thematic Equity Oriented Funds:

    Through this fund, an investor can invest the corpus of the fund into companies belonging to a particular theme that he may believe has good growth potential.

  6. Index Funds:

    These funds are made to mimic a pre-existing financial stock market index, hoping that it would guarantee the same kind of returns as the original portfolio.

  7. Focused funds:

    These funds limit the investments of their corpus by investing in a maximum of 30 stocks.

  8. Equity Linked Savings Scheme (ELSS):

    These are a type of diversified equity fund where the investors can claim tax deductions in exchange for a lock-in period of investment of 3 years. These are also termed as tax saving mutual funds. Here, you may claim tax deductions of up to INR Rs.1.5 lakh, according to Section 80C of the Income Tax Act.

Types of Equity Funds

  1. Diversity of Funds to Choose From:

    Equity funds are highly advantageous, liquid and diverse. As mentioned above, there are various kinds of equity funds available in the market based on the market capitalisations, risk factors and investment strategies.

  2. Dependency on The Fund Manager:

    By investing in an equity fund, you rely on a fund manager to offer professional management by conducting accurate research and diving into the past to realise the most beneficial schemes for you.

  3. Liquidity:

    Based on the kind of investor you are, you can select one amongst multiple equity funds available in the market. You may invest in an equity fund that invests a part of its corpus into debts and market securities to retain the safety and liquidity of the fund.

  4. Tax Deductions:

    The ELSS fund also offers tax deductions from your taxable income as a major advantage.

  5. Systematic and Regular, Thoughtful Investments:

    All of these funds let you invest at regular intervals and a smaller amount through SIP, which is yet another attractive feature as it puts you into a habit of disciplined investing.

Amongst all the mutual funds, equity-oriented mutual funds have been generally observed to offer better returns in the Indian market. However, the funds fluctuate based on market risks and clashes. These funds may generally deliver returns up to 10-12% in a bullish market. Although equity funds are very attractive in terms of returns, they are also subject to market risks, and must be invested into after thorough research has been conducted on each kind.