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Why Equity-oriented Mutual Funds is Important For Long Term Wealth Creation? Thursday, Jan 23, 2020

Equity-oriented mutual funds invest a dominant portion of their assets in equity and equity related instruments. Broadly, the investment objective of an equity-oriented mutual fund is to generate capital appreciation over the long term.

Thus, to plan for long-term financial goals and clock effective inflation-adjusted returns (also known as the real rate of returns), equity-oriented mutual funds are an appropriate choice.


That said, the prudent selection is the key. You have a variety of options to choose from. As per the capital market regulator’s diktat on mutual fund re-categorization, there are 10 sub-categories of equity mutual funds:

      1. Large-cap Fund

      2. Large & Midcap Fund

      3. Midcap Fund

      4. Small-cap Fund

      5. Multi-cap Fund

      6. Dividend Yield Fund

      7. Value/Contra Fund

      8. Focused Fund

      9. Sectoral/Thematic Fund

      10. ELSS (Equity Linked Savings Scheme)

Each scheme has distinct characteristics - these are defined by the regulator. Let’s understand the trait of each one.

1) Large-cap Fund – A large-cap fund is required to invest a minimum of 80% in equity & equity related instruments of large-cap stocks (i.e. first 100 companies on full market capitalisation basis).

Suitability: If you are looking at growth and stability with exposure to blue-chips and predominantly larger companies while you endeavour to create wealth, this sub-category of equity fund can be apt. When the equity markets turn turbulent, a pure large cap fund can arrest the downside risk better compared to their pure mid-cap counterparts and even large & mid-cap peers. When investing in this fund, your investment time horizon should be around 5 years.

2) Large & Mid-cap Fund – A large & mid-cap fund is required to invest minimum 35% investment in equity & equity related instruments of large-cap companies and simultaneously maintain minimum 35% allocation to mid-cap stocks (i.e. companies from 101st to 250th on full market capitalisation basis). The remaining portion is parked in debt & money market instrument.

Suitability: When you plan for long-term goals and want the stability of large-caps along with the agility of mid-caps in the journey of wealth creation, a large & mid-cap fund could be an appropriate fit. Here again, your time horizon should be at least 5 years.

3) Midcap Fund – A mid-cap fund, as the name suggests and as defined by the regulator, invests a minimum 65% of its total assets in mid-cap stocks (i.e. companies from 101st to 250th on full market capitalisation basis).

Suitability: Mid-cap funds offer you the potential to generate significant wealth. However, do note that the risk is substantially magnified.
During bull phases, mid-cap funds tend to outperform their pure large-caps and even large & mid-cap peers by a significant margin. Conversely, in the bear periods, they also have a tendency to plunge more.
Hence, invest only if you have the stomach for very high risk and have a fairly long investment time horizon of at least 5-7 years.

4) Small-cap Fund – A small-cap invests a minimum of 65% of its total assets in equity & equity related instruments of small cap companies. (i.e. companies that are 251st onwards on a market capitalisation basis). Small-cap stocks, due to their size, usually have a low trading volume. Thus note that the risk associated with small-cap funds is greater than even the mid-cap funds.

Suitability: Small-cap funds have the tendency to go from thrilling highs to dangerous lows. Therefore, as an investor, you need to be wary of high volatility and have an appetite for very high risk. If you are looking to boost your long-term returns and investment time horizon is 7 to 10 years, you may consider investing some portion in a small-cap fund/s.

5) Multi-cap Fund – A Multi-cap Fund invests across the large-cap, mid-cap, small-cap stocks with a minimum 65% investment in equity & equity related instruments. So, you get the best of both worlds --- the high-return potential of mid-and-small-caps and stability of large-caps. Usually, multi-caps funds maintain a stable allocation to large-cap and mid-cap stocks.

Suitability: On the risk-return spectrum, multi-cap funds usually fall between large-cap funds and mid-cap and small-cap funds. Hence, if you are willing to take high risk and want to enjoy capital appreciation across market capitalisation segments, a multi-cap fund may be appropriate for an investment time horizon of at least 5 years.

6) Dividend Yield Fund – A dividend yield fund, as characterised by the regulator, is required to predominantly invest in dividend yielding stocks and hold a minimum 65% investment in equities. These funds usually invest in companies that report robust earnings and have a history of declaring appealing dividends. Note that such companies are always on the investment radar of many value investors.

Suitability: Since dividend history is a true measure of ascertaining the true worth of the company (in midst of all business cycles and volatility of the equity markets), dividend yield funds may be worth it if you are looking to safeguard against extreme volatility. But remember, you need to have an appetite for high risk and an investment time horizon of at least 5 years.

7) Value/Contra Fund – A value fund/ contra fund follow a defined style of investing, namely value and contra, and maintain a minimum 65% investment in equity & equity related instruments.
Value investing involves identifying fundamentally sound stocks that are trading at a discount to their fair value.
Fund managers adopt different approaches to value investing. So, value investing finds its place in the profound quote, “Beauty lies in the eyes of the beholder” by the Greek philosopher, Plato.
Contra funds follow to adopt a contrarian style of investing and are an alternative provided by the regulator to Value Funds. This means, a fund house can have either a Value Fund or Contra Fund, but not both; for a simple reason that ‘contra investing’ is a subset of value investing.

Suitability: Value and contra funds are suitable if you have the stomach for high risk and an investment time horizon of at least 5 years. On the risk-return spectrum, they are notch above dividend yields funds.

8) Focused Fund – These funds limit the maximum number of stocks in the portfolio (to a maximum of 30), and invest a minimum 65% of its assets in equity & equity related investments. So, the fund manager holds a conviction-oriented portfolio in order to enhance returns.

Suitability: Focused equity funds expose you to concentration risk. The fund on the risk-return spectrum is placed higher, just a mark below the mid-cap and small-cap funds. Hence, invest in a focused fund if you have the capacity for high risk and an investment time horizon of at least 5 to 7 years.

9) Sectoral/Thematic Fund – Sector and Thematic Funds have a mandate to invest in a respective sector or a theme, viz. pharma, banking & financial services, pharma & healthcare as per the view formed and opportunities for the sector or theme.

Suitability: The fortune of a sector and thematic funds is closely linked to the fortune of the underlying theme or a sector. Thus, the portfolio concentration makes them a very high risk-high return investment proposition vis-à-vis diversified equity funds that hold the mandate to invest across sectors and various market capitalizations (whereby the risk is reduced). Sector/thematic funds are not for the faint-hearted. They are placed at the top on the risk-return spectrum.

10) ELSS (Equity Linked Savings Scheme) – ELSS (also known as tax saving funds) is basically a diversified equity fund. Investments in ELSS are subject to a lock-in period of 3 years and eligible for a deduction (up to Rs 1.5 lakh p.a.) under Section 80C of the Income Tax Act,1961.

Suitability: If you are a risk taker, then ELSS is a promising investment avenue for tax planning and to grow your wealth. But your investment time horizon should ideally be at least 3-5 years when you invest in them.
There are certain hybrid equity funds as well, that can be a part of your wealth creation portfolio. Hybrid funds provide with you the best of both worlds–capital appreciation of equity assets and the regular income of debt securities.

The five varieties of Hybrid Funds are:

1) Balanced hybrid/Aggressive Hybrid Fund

2) Dynamic Asset Allocation Fund or Balanced Advantage Fund

3) Multi-asset Allocation Fund

4) Equity Savings Fund

5) Conservative Hybrid Fund

Depending on their exposure to equity, these funds can be further classified into Conservative Hybrid Funds, Aggressive Hybrid Funds, Balanced Hybrid, Dynamic Funds, etc.

Depending on their exposure to equity, these funds can be further classified into Conservative Hybrid Funds, Aggressive Hybrid Funds, Balanced Hybrid, Dynamic Funds, etc.

For long-term wealth creation, in the hybrid fund category, an aggressive hybrid fund and/or Dynamic Asset Allocation Fund or a Balanced Advantage Fund is a more appropriate choice.

11) Aggressive Hybrid Fund – An aggressive fund, on the other hand, invests 65% to 80% of its total assets in equities and 20% to 35% in debt instruments. Since the portfolio is skewed to equities; they are termed as ‘aggressive’.

Suitability: If you have a higher risk appetite and follow a tactical asset allocation, an aggressive hybrid fund would be an appropriate choice. That said, your investment time horizon ought to be at least 3 to 5 years.

12) Dynamic Asset Allocation Fund or Balanced Advantage Fund – The allocation to equity and debt is managed dynamically by such a fund. So, it can hold 0 to 100% in equity or 0% to 100% in debt, which means there’s no restriction on minimum or maximum exposure to either equity or debt.
The fund can choose to be fully allocated either to equity or debt instruments depending on the fund manager’s view of the market. Certain dynamic funds have a formula-driven approach that takes into consideration market valuations and other factors. The allocation is-decided based on the formula that defines equity exposure based on the different variables.
Though a Balanced Advantage Fund also set their asset allocation as per the direction of the market, they tend to keep a minimum 65% exposure to equity at all times.

Suitability: The risk a dynamic asset allocation fund exposes you to would depend on its exposure to equity and debt over a period of time. For a dynamic exposure to equity and debt, a dynamic asset allocation fund may be suitable, provided your investment time horizon is at least 3 to 5 years and willing to assume moderate-to-high risk.
However, if the fund holds the portfolio in the nature of a balanced advantage fund (i.e. keep a minimum 65% exposure to equity at all times), then the risk-reward potential would be similar to that of an aggressive hybrid fund.

Broadly, who should invest in equity-oriented funds?
Every type of equity-oriented mutual fund carries a distinct risk-reward relationship. But speaking very broadly, consider investing in an equity-oriented mutual fund only if you can handle high risk and your investment time horizon is at least 3-5 years while you endeavour to build wealth.


Disclaimer, Statutory Details & Risk Factors:

The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments.

Mutual fund investments are subject to market risks read all scheme related documents carefully.

Please visit – www.QuantumMF.com to read scheme specific risk factors. Investors in the Scheme(s) are not being offered a guaranteed or assured rate of return and there can be no assurance that the schemes objective will be achieved and the NAV of the scheme(s) may go up and down depending upon the factors and forces affecting securities market. Investment in mutual fund units involves investment risk such as trading volumes, settlement risk, liquidity risk, default risk including possible loss of capital. Past performance of the sponsor / AMC / Mutual Fund does not indicate the future performance of the Scheme(s). Statutory Details: Quantum Mutual Fund (the Fund) has been constituted as a Trust under the Indian Trusts Act, 1882. Sponsor: Quantum Advisors Private Limited. (liability of Sponsor limited to Rs. 1,00,000/-) Trustee: Quantum Trustee Company Private Limited. Investment Manager: Quantum Asset Management Company Private Limited. The Sponsor, Trustee and Investment Manager are incorporated under the Companies Act, 1956.