Equity mutual funds are known for their high-return potential but also carry a high risk. These funds are divided into categories based on market capitalisations, investment strategies and tax benefits. Keep reading to know more.
Equity funds are one of the most popular types of mutual funds among investors. Thanks to their high-return potential, many include it in their investment portfolio. However, there are various type 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 understand what an equity fund is?
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 give liquidity and lower the risk-level 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 based on market capitalisations, investment strategies and tax benefits.
These 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. Or in other words, they have a capitalisation of less than Rs. 500 crores.
Since this fund invests majorly into small-cap companies, they carry a high-risk, but it also has high-returns potential.
They may be preferable for aggressive risk-taking investors with a long investment horizon.
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 capitalisation ranging from Rs. 500 to 10,000 crores, and ranked from 101 to 250 in a stock exchange as per their market capitalisation.
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 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.
These funds invest across 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 people with moderate risk tolerance looking for potential long-term gain horizons.
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.
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.
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.
Since they mimic an index, they are for conservative investors with a long-term horizon.
These funds limit the investments of the corpus by allowing 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.
Since the fund focusses on only 20-30 stocks, it carries a high risk but also comes with high return potential.
This is suitable for aggressive investors that aims to gain more control over the fund by deciding on a fund based on the stocks it plans to invest.
While all the different types of equity mutual funds enjoy tax benefits on long-term investments, one type comes with an added tax benefit.
Also, 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 one 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 come with moderate return potential.
Since they come with low-risk level and 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.
As you can see, there are different types of equity mutual funds suited for all types of investors. Whether you are an aggressive investor, a moderate investor or a conservative investor, you can find an equity fund that will suit your risk profile. However, it is essential to choose the right type of equity fund to add to your portfolio, especially when you are just starting your investment journey. Keep factors such as investment horizon, risk appetite and financial goals in mind to decide on the best equity fund.