What Are Equity Mutual Funds and Types of Equity Mutual Funds

Mutual funds are gaining popularity as they offer investors the opportunity to diversify investments, spread the risk, and earn market linked  returns. It allows an average investor to invest in a professionally managed scheme that aligns with their investment objectives, risk profile, and investment horizon. If you have long-term financial goals to address, an investment horizon of at least 3 to 5 years, and a high-risk appetite, consider investing in equity mutual funds. The objective of the Equity Mutual Fund is to seek long-term capital appreciation and wealth creation.

To differentiate the funds from one another and better understand the funds you invest in, it is crucial to learn about different categories and types of Equity Mutual funds. But before that, let’s understand what an Equity Mutual Fund is.

What is an Equity Mutual Fund?

Equity Mutual funds can never be separated from the risk associated with investing in them. Yet they are among the popular investment avenues as the returns potentially outweigh the risk involved. The objective of an Equity Mutual Fund is to outperform its respective benchmark index.

An Equity Mutual Fund invests a majority of its underlying assets in equity shares of different companies across different sectors, with the fund manager actively managing the portfolio. A small portion of its assets could be invested in debt, money market securities, and cash equivalents.

Since an Equity Mutual Fund is highly dependent on the stock market, it carries higher risk compared to other types of mutual funds. Equity Funds seek growth and offer capital appreciation in the long term but could be highly volatile in the short term. Hence, these funds are suitable for investors with a high-risk appetite and a longer investment horizon of, say, at least 3 to 5 years.

What are the Types of Equity Mutual Funds?

There are several types of Equity Mutual Funds, and each category of fund offers a different portfolio strategy and has a different level of risk. You should choose an Equity Mutual Fund scheme that suits your requirement and help create your winning portfolio. As per the SEBI guidelines on Categorisation and Rationalisation of schemes, the Equity Fund can be further categorised into twelve sub-categories:

Large Cap Funds:
Large Cap Funds are the type of Equity Fund that predominantly invest their assets in large-cap stocks. They are mandated to invest at least 80% of their underlying assets in equity and equity-related instruments of large Cap companies i.e., the first 100 companies, in terms of full market capitalisation.

Mid Cap Funds:
Mid Cap Funds are mandated to invest at least 65% of their funds’ corpus into mid-cap stocks. Mid-cap stocks are equity and equity-related instruments of medium-sized companies. These are the companies that are from 101st to 250th on a full market capitalisation basis. 

Small-Cap Funds:
Small-Cap Funds invest the majority of their assets into small-cap stocks. As per SEBI, these funds are required to invest at least 65% of their underlying assets into equity and equity-related instruments of small-sized companies that rank from 251st onwards on a full market capitalisation basis.

Large & Mid Cap Funds:
Large & Mid Cap Funds offer exposure to both the stocks by investing at least 35% of the assets in large-cap stocks and simultaneously holding at least 35% in mid-cap stocks. Since they invest the majority of funds’ corpus into equity and equity-related instruments of large and medium-sized companies, it offers the stability of investing in large-cap and good return potential of mid-cap funds in a single fund.

Multi-Cap Funds:
SEBI mandates Multi-Cap Funds to invest at least 25% of their underlying assets into each segment, i.e., large, mid, and small-cap stocks and maintain the mix irrespective of the market condition. As they invest in equity and equity-related instruments of all three types of companies, they offer maximum diversity in a single scheme. 

Flexi Cap Funds:
Flexi Cap Funds are mandated to invest a minimum of 65% of their total assets in equity & equity-related instruments with exposure across market caps. However, there is no minimum limit or restriction specified for any market cap segment. These funds focus on investing across the market capitalization spectrum and hold a portfolio spread across large-cap, mid-cap, and small-cap stocks.

Dividend Yield Funds:
Dividend Yield Funds are open-ended equity mutual funds that invest at least 65% of the total assets into dividend-yielding stocks from any market capitalisation segment. Although these funds predominantly invest in equity and equity-related instruments of the companies that regularly declare dividends, there is no guarantee about the amount and frequency of the dividend.

Value Funds:
Value Funds follow the value investment strategy and invest at least 65% of their total assets in equity and equity-related instruments. The value investing strategy focuses on buying undervalued stocks and holding them for a long duration. These funds can underperform in the short and medium-term but have the potential to offer good high returns in the long term. You can consider investing in Value Funds if you are a long-term investor who knows the macro trends and is ready to digest some underperformance even when the markets are in a bullish phase and favouring growth-oriented stocks.

Contra Funds:
Contra Funds follow the contrarian investment strategy and invest at least 65% of their total assets in equity and equity-related instruments. Contrarian investment strategy focuses on buying out-of-favour stocks that are temporarily ignored by the investors but have the potential to outperform in a fund manager’s opinion. The fund manager believes that the stocks are temporarily underperforming due to a current problem, and once it is solved, the stocks are expected to outperform.
Although Value Funds and Contra Funds may sound similar, the major difference between the two is that the Value Funds invest in undervalued stocks, whereas Contra Funds invest in those that are underperforming in the market.

Focused Funds:
Focused Funds invest their corpus into a limited number of stocks. SEBI mandates Focused Funds to invest in a maximum of 30 stocks with at least 65% of total assets in equity and equity-related instruments. These funds aim to earn maximum returns through investing in maximum 30 high-conviction stocks.
Focused Funds may focus on large, mid, or small-cap funds. They typically focus on a few sectors maximum 30 stocks instead of spreading assets over a large number of stocks. 

Sectoral/Thematic Funds:
Sectoral Funds invest the majority (at least 80%) of their assets into a particular sector, such as pharma, automobile, FMCG, banking, IT, etc. If you believe that a particular sector or industry has growth potential, you can consider investing in a Sectoral Fund of that particular sector.
Similarly, Thematic Funds invest at least 80% of their total assets into a particular theme. For instance, an infrastructure theme-based fund invests in cement, power, steel, real estate, and the sectors that are related to infrastructure. Due to the limited exposure, the Sectoral Funds are considered riskier than Thematic Funds. 

Equity Linked Saving Scheme (ELSS):
The SEBI defines Equity Linked Saving Schemes or ELSS as open-ended equity schemes that come with a statutory lock-in period of 3 years and tax benefit.These funds invest a minimum of 80% of their total assets in equity and equity-related instruments and have the flexibility to invest across sectors and the market cap spectrum. It is the most sought-after tax-saving instrument that offers both the benefits – of tax saving and wealth creation. Although the mandatory lock-in period for ELSS Mutual Funds is three years, you may consider investing in them if you have an investment horizon of more than 3 to 5 years. The amount you invest in an ELSS is eligible for a deduction under section 80C of the Income Tax Act, 1961, up to Rs 1.50 lakh in a financial year. 

How does equity mutual fund work?

Equity mutual funds pool money from multiple investors to invest primarily in stocks or equities. It is a mutual fund scheme that primarily 65% or more of its total assets in equities and equity related instruments of different companies. An Equity mutual fund can be categorized as per its market cap, investment style or geography.

How should you invest in an Equity Mutual Fund?

Before investors choose to invest in Equity mutual funds, they need to consider their risk appetite, investment horizon & financial goals.One should note that different equity funds work differently depending on the market cycle. Hence, it is suggested to follow a diversified portfolio of equity funds to navigate the market movements.

Features of an Equity Fund:
1.

Capital appreciation: Equity mutual fund is ideal for fulfilling the objective of building wealth over the long term.
2.

High Risk: While equity mutual funds offer the potential for higher returns compared to other investment options, they also carry higher risk due to their exposure to the equity market.
3.

Liquidty: Equity mutual funds are liquid investment avenues offering flexibility to purchase or redeem as necessary.

Benefits of investing in Equity Mutual Funds

Flexibility: You can redeem or purchase units of equity mutual fund schemes partially or fully at any time.

Accessibility: The minimum investment in equity mutual funds can be Rs 5,00 monthly or Rs. 100 daily in certain schemes.

Diversification: Equity mutual funds invest in a broad portfolio of stocks across different sectors and industries offering diversification.
Inflation: Equity mutual fund helps to cope with rising commodity prices.

Taxation rules of Equity Funds

Capital Gains Tax: The tax treatment of capital gains from mutual funds varies depending on the investor’s holding period. Equity mutual funds held for less than a year are subject to short term capital gains tax at 15% p.a. Short-term capital gains are taxed higher than long term capital gains. Equity funds held for more than a year are taxed at 10% p.a.

Depending Dividend Distribution Tax (DDT): Earlier dividends were tax free in the hands of investors but were taxable at source at the scheme level. Now the dividend option is christened as IDCW option and is taxable at the hands of the investor as per marginal tax rates. TDS is levied at a rate of 10% on IDCW income over Rs 5,000 received from mutual funds.

To Conclude:

Equity Mutual Funds are riskier compared to any other types of mutual funds, but they have the potential to earn risk adjusted returns in the long term. Hence, if you are looking for market-linked returns, ready to take the risk for the potential to earn good returns, and have a long investment horizon, Equity Mutual Funds are ideal for you.
Now that you are aware of the different types of Equity Mutual Funds and their characteristics, you are ready to take a plunge. Choose the Equity Mutual Fund schemes considering your risk appetite, investment horizon, and investment objective. If you are facing any difficulty while analysing your profile or selecting the funds, take the help of professionals who will guide you throughout your investment journey and help create a winning portfolio to achieve your financial goals.
Happy investing!

Above article is authored by Quantum.

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