Mutual Funds have always been a great way to create wealth. There are different types of Mutual Funds that you can invest in depending on your investment objectives, risk profile, and time horizon. One among the many types is the Equity Mutual Funds which will be discussed briefly below.
What is an Equity Mutual Fund?
Equity Mutual Fund invests in the equity shares of different companies in different proportions. Equity Funds can generate higher returns than other funds like Debt or Hybrid Mutual Funds. With higher returns comes the higher risk that is associated with Equity Mutual Fund. Risk in Equity Funds is high because of the high fluctuations of the stock prices.
How does Equity Mutual Fund work?
The Fund Manager of the Equity Mutual Fund i.e. the person who manages the portfolio of a particular Fund invests a minimum of 65% of the total assets of the Fund in Equity instruments as in shares of different companies. The rest of the assets are either invested in Debt securities or kept as cash so that if all of a sudden people start redeeming their units the Mutual Fund can payout the amount receivable by them. Also, the presence of little debt helps the equity mutual fund to be on the safer side.
In Equity Funds, the Fund Manager actively involves himself in buying and selling the shares under its portfolio according to the changes in the market to give you higher returns.
Types of Equity Mutual Funds
There are different categories on the basis of which the Equity Funds can be divided.
1. Sectoral/Thematic Equity Fund
As the name suggests Sectoral Funds invest in the shares of the companies belonging to a particular sector like PHARMA, FMCG, AUTO, BANKS, etc.
Since these funds invest only in a particular sector, they are exposed to higher risk. You must be wondering, How? Let’s say you invested in the Fund that invests only in the Pharma companies. Now, there can be two scenarios. One, that the Pharma sector is performing well and so you would get significant returns. But on the other side, what if the sector overall is not performing well? Then the fund might go into losses as it had only invested in Pharma companies.
Therefore, the risk involved in Sectoral/Thematic Funds is high and not suitable for those investors who cannot tolerate higher risk.
2. Based on Market Capitalization
Let us understand, What is Market Capitalization?
Market Capitalization tells us the total value of the company traded on the stock market. It is calculated by multiplying the Total No. of Shares by the Current Market Price (CMP).
So, the Equity Funds can also be divided based on capitalization of the companies they invest in. They are:
- Large-Cap Equity Funds: Large-Cap Fund invests at least 80% of its total assets in the top 100 Large Cap companies whose market capitalization is more than 7000 Cr and up to 20,000 Cr. These companies are huge, well established, and financially stable. So these Funds are capable of offering stable returns.
- Mid-Cap Equity Funds: Mid-Cap Funds invest at least 65% of the total assets in the companies ranked from 101-250 (as per market cap) that have a market capitalization of more than 500 Cr and less than 7000 Cr. These companies are generally in their growth phase and have the potential to give high returns than Large-Cap companies but with the cost of higher risk, as these companies are more volatile than Large-cap companies.
- Small-Cap Equity Funds: Small-Cap Funds invest 65% of their total assets in companies ranked below the top 250 companies whose market capitalization is less than 500 Cr. These are generally new companies and have significant potential to grow but also have the risk to fail. So, these Funds can generate great returns if the company selected by the Fund Manager continuously grows, but also these funds can give you a really bad hit if the companies fail. Only those investors who can take a great amount of risk should think of investing in Small-Cap Funds.
- Multi-Cap Equity Funds: Multi-Cap Funds invests 65% of their total assets in the shares of large-cap, mid-cap, and, small-cap companies in different proportions. Here, the Fund Manager keeps on changing the Fund’s portfolio i.e. the proportion of allocations in the different capitalization of companies, according to the market conditions and the investment objective of the Fund.
- Large-cap and mid-cap Equity Fund: These Funds invest 35% of their total assets in large-cap companies and 35% of the assets in mid-cap companies. This fund is suitable for those investors who want to take low risk but earn higher returns, as the large-cap companies would help you lower the risk and you can enjoy high returns from the mid-cap companies.
3. Based on the Investment Style
- Active Funds: In Active Funds, the Fund Manager is responsible for managing the portfolio of the Fund and rebalancing the portfolio i.e. buying and selling the shares, according to the Market condition. For example, in a Large-Cap fund, it is the Fund Manager who manages the portfolio of the Fund, so it is an Active Fund.
- Passive Funds: Passive Funds can also be called Index Funds. Passive Funds invest in all the stocks in the same proportion as the index. For example, the Nifty 50 is one of the main Indexes of the Indian Stock Market. So, a Nifty 50 Index Fund will invest in all the 50 stocks of the Nifty 50 and the same proportion as the Index. These Funds are not managed by the Fund Manager and so are considered as a low-cost fund. These Funds perform more or less in the same way as the particular Index.
4. Equity Linked Saving Scheme (ELSS)
ELSS is a scheme that invests mostly in Equity instruments and is the only scheme that offers a deduction of up to 1.5 Lakhs under section 80C. However, this scheme has a lock-in period of 3 years, which means that you will have to stay invested in this scheme for a minimum period of 3 years after which you can redeem your units.
5. On the basis of Profit Distribution and Growth Prospects
- Dividend Yield Equity Fund: Equity Funds that invest 65% of their assets in companies that are capable of producing High Dividend ( Dividend is a part of the profit that the company distributes to the shareholders) can be known as Dividend Yield Equity Fund. However, the amount of dividend is not fixed and the companies don’t need to provide you dividend every time, as the companies have the right to retain the dividend with themselves and reinvest. But the objective of this fund is to invest in those companies that generate high dividends.
- Value Equity Fund: These funds invest in the companies that are currently undervalued, which means that the price of the share of that company should be much more as per its valuation and these companies have good future growth potential but are available at a cheaper rate.
- Growth Equity Fund: These funds invest in companies that have high growth potential, earnings and that reinvest their profit for the growth of the company. These companies either provide you with a low dividend or no dividend at all.
Pros and Cons of Equity Mutual Fund
Everything has a positive and a negative side. Similarly, some of the pros and cons of investing in Equity Mutual Funds are given in the following table:
|Equity Funds are known for providing higher returns as compared to other funds, which will help you create wealth in the long run.||Equity Funds except Index Funds are managed by Fund Managers, thus they have a high expense ratio i.e. cost. As the Fund Manager charges certain fees to manage the portfolio.|
|Equity Funds (except Index Funds) are managed by Fund Manager who has great expertise and experience in managing the portfolio of the Fund.||Equity Funds have a higher risk compared to other Funds because of higher volatility and so is not a good option for those who cannot afford to take much risk.|
|ELSS provides you with tax benefits of up to 1.5 lakh under section 80C and helps you in reducing your tax burden.||ELSS has a lock-in period of 3 years i.e. you won’t be able to redeem your units before 3 years.|
|Equity Funds except ELSS provides easy liquidity i.e. you can convert your investments into cash within one or two working days.|
|Equity Funds helps you diversify your portfolio as you get exposure to the share of different companies under the same roof, rather than investing in each separately.|
Who should invest in Equity Funds?
Now, we know that Equity Funds invest in the shares of different companies. There are many factors that you as an investor must look into before investing like your investment objective, the time for which you want to invest, the risk that you can afford, the expense ratio of the fund, etc.
However, the Equity Mutual Fund is ideal for those investors who can afford medium to high risk because of higher fluctuations in the share prices of the companies. Also, these Funds would give you significant returns if you invest for a medium to long term time frame.
If you as an investor hold the units of the Equity Mutual Fund for more than a period of 1 year, the gain that you will earn will be known as Long Term Capital Gain (LTCG). LTCG over and above the minimum deduction of 1 Lakhs is taxable at 10%.
And if you hold the units of the Fund for less than 1 year then the gain would be termed as Short Term Capital Gain (STCG). STCG is taxable at 15%.
For example, if you invest in Axis Large-Cap Fund for 1.5 years. And you earn a return of Rs 2 lakhs then you will be taxed at 10% and only on Rs. 1 lakh.
Dividend Distribution Tax (DDT)
Dividend is usually a part of the profit earned by the company, that is given out to the shareholders of that company as a sign of reward.
So, when the company that is in the portfolio of the Fund you invested in gives a dividend, the Mutual Fund provides the same to you. However, the dividend that you get is taxed at the hands of the Mutual Fund at 10% if the amount exceeds Rs. 5000 and it is known as DDT.
For example, if you earn a dividend of Rs. 2000, then no amount will be taxable at source as it is below Rs. 5000 and you will get the full amount.
Well, Investing is a good way of growing wealth. But your investments will be in your favor if you understand and then invest. Equity Funds are capable of providing significant returns if you invest in the right Fund that matches your objectives and as a long-term investment. However, higher returns signify high risk, so Equity funds are suitable for investors who have a high risk-taking capacity.
Equity Mutual Fund invests in the shares of different companies in different proportions. It invests a minimum of 65% in shares and the rest in Debt securities or hold as cash to meet sudden redemption requests and to be on the safer side.
There are two modes through which you as an investor can invest in Equity Funds:
1. Systematic Investment Plan (SIP) – In SIP you can invest a fixed amount as low as Rs. 500 at regular pre-decided intervals of time. The intervals can be weekly, monthly, quarterly, semi-annually, and annually. And,
2. Lumpsum investment – In Lumpsum investment mode you can invest a large amount in a single investment.
Yes, if you are an investor who can afford to take moderate to high risk and want to invest for the long term, then Equity Fund can give you significant returns.
Equity Linked Savings Scheme (ELSS) is a type of Equity Funds that invests mostly in equity instruments and is the only scheme that offers tax benefits of up to Rs. 1.5 Lakh under section 80C.