What are Equity Mutual Funds?

When we hear about Mutual Funds, we immediately think of stock markets. This is because the rise in popularity of equity Mutual Funds for retail investors (general public like us) can be related to the introduction of the Equity Linked Savings Scheme, better known as ELSS, which was introduced in the year 2005. But Mutual Funds can be categorised into three main types and not just equity funds, as explained in my last post.

Due to widespread recognition of equity funds, retail fund flow in the equity markets has risen manifold over the years. However, from what I have observed, the retail investors have restricted their investment in equity funds only to the ELSS, when the industry has a plethora of other categories to offer. Today, we shall learn about equity funds and their different types in brief.

As the name suggests, an Equity Fund invests in equity shares/stocks of various companies. The funds are managed by qualified & experienced professionals giving a certain degree of assurance regarding the safety of our investments. The main objective of any fund manager is to maximise capital appreciation and for achieving the same, he invests in companies across different sectors or with varying market capitalisations driven by the objective of the mutual fund scheme. To understand more about equity funds, let’s have a look at their different categorisations.

Market Capitalisation based:

Large-Cap Funds

• invest at least 80% of their total assets in equity shares of large-cap companies (top 100 companies having ~80% of market capitalisation);
• offer more stable returns than the mid-cap or small-cap focused funds as investments are made in well-established companies with a proven track record.

Mid-Cap Funds

• invest a minimum of 65% of their total assets in equity shares of mid-cap companies (101–250th ranked companies based on market capitalisation);
• offer better returns than the large-cap schemes but are also more volatile than them.

Large & Mid-Cap Funds

• invest at least 35% of their total assets in equity shares of large-cap companies and 35% in mid-cap companies;
• offer higher returns (due to mid-cap allocation) at lower volatility (due to large-cap allocation).

Small-cap Funds

• invest a minimum of 65% of their total assets in equity shares of small-cap companies (251st and below ranked companies based on market capitalisation);
• over 96% of all listed companies (but carry only ~5% of market capitalisation) in India fall in this category;
• offer higher returns than the large-cap and mid-cap schemes but are also highly volatile.

Multi-Cap Funds

• invest at least 65% of their total assets in equity shares of large-cap, mid-cap, and small-cap companies in varying proportions;
• fund manager does periodic rebalancing of the portfolio depending on the economic conditions & other macro factors as well as the investment objective of the scheme.

Investment Strategy based:

Dividend Yield Funds

• predominantly invest at least 65% in companies that have a history of paying dividends at regular intervals;
• ideal for those investors who are looking for a steady stream of income.

Value Funds

• invest a minimum of 65% in stocks that are currently undervalued as per the fund manager’s assessment but are expected to perform well over time as the value is unlocked.

Contra Funds

• follow a contrarian investment strategy with at least 65% in stocks;
• the fund manager takes a contrarian view of a stock when it is shunned by the investors or when there is a euphoric demand for it.
• both the over-performance and the under-performance of stock lead to a distorted value of the asset which the fund manager tries to take advantage of.
• the underlying belief is that any exorbitant price of a stock will eventually normalize in the long-term once the existing conditions wean off.

Focused Funds

• follow the objective defined at the launch of the scheme with at least 65% of investment in equity instruments.
• capital is deployed only in select stocks (maximum 30);
• these are typically high conviction bets that a fund manager believes will outperform;

Sectoral/Thematic Funds

• mandated by SEBI to invest at least 80% in stocks of a particular sector/theme.
• thematic funds follow a specific investment theme like an electric vehicle theme or infrastructure theme, etc.;
• sectoral schemes invest in a particular sector of the market like IT, Pharma, BFSI, etc.
• however, thematic funds are more broad-based than sectoral funds, as they pick companies across different sectors driven by an idea.
• important to note that sector or theme-based funds carry a higher risk since they focus on a specific sector or theme.

Tax Treatment based:

ELSS/Tax Saving Funds

• invest at least 80% in stocks in accordance with Equity Linked Saving Scheme, 2005.
• mainly used as a vehicle for saving taxes. In addition to saving taxes, they also provide good capital appreciation in the long run.

Non Tax Saving Funds

• except ELSS, all funds are non-tax saving funds.

As mentioned above, investors have a wide range of options when it comes to investing in equity funds. However, not all types of equity funds suit/fulfil the investment objectives of all investors. Hence, in the next blog, we shall understand the factors to be considered while investing in an equity fund along with the risks involved & the suitability of each fund.