Equity mutual funds are also known as stock funds or equity funds. While there are many different types of equity mutual funds in India, diversified equity funds are known to be the most popular ones.
But first, let’s define what a mutual fund is. Essentially, a mutual fund is a shared fund that pools money from a large number of investors. The collected corpus is further invested in bonds, stocks, short-term money-market instruments, and so on. The equity mutual funds invest their monies in the equity market or the share market, as it is popularly known.
The reason why this type of funds is popular is due to the fact that it offers high returns with relatively lower risk due to diversification. Investors want to reduce their overall portfolio risk by investing in a large number of stocks. Hence, by holding roughly 30 stocks, you reduce the chances of having a single stock ruin your entire portfolio. This can be easily achieved through an equity mutual fund.
That being said, let’s have a look at the different types of equity mutual funds in India. It would be good to remember that going after the best performing funds may not be always suited; an investor has to take a step back to make sure that they have chosen a right equity fund which is appropriate for their risk profile.
High Risk Equity Mutual Funds
When should you consider high-risk funds? If you have a consistent source of income, and age is by your side, then you might consider investing in mid-cap funds, small cap funds, sector funds, as well as opportunity funds.
That’s because these funds would give high returns over a longer period of time. Ideally, you should have a 7 – 10 years horizon, at least to consider these types of funds. Essentially, midcap funds invest in middle level companies, small caps invest in small companies, sector funds focus on a particular sector or theme and opportunity funds look for emerging opportunities in the market. Therefore, you need to have a long-term investment perspective, to consider including these funds in your portfolio.
Medium Risk Equity Mutual Funds
If you prefer to go for a medium risk exposure, diversified or multi-cap funds, large-cap funds and focused equity funds are the ones you should be looking at. As the name suggests, diversified or multi-cap funds invest across different sectors and different sized companies. Large cap funds are exclusively focused on the largest companies in the market and they would not include the mid-sized or small companies in their portfolio, which is a great way to mitigate risk. Focused equity funds limit the number of stocks they hold to those companies in which the fund manager has the highest level of conviction. This strategy helps avoid over-diversification as well as enjoying the returns from the best possible stocks. Ideally the investment horizon for these types of funds should be around 5 years.
Balanced or hybrid funds are another option for those seeking medium risk. If your investment tenure is around 3 – 5 years, you may not want to expose yourself completely to the equity market. So, it might be a good idea to start with balanced funds. Usually, around 65 percent of the assets are invested in equity, whereas the balance is invested in debt instruments. A mix of these assets entails a significant level of diversification, which reduces the risk, in comparison to a pure equity fund. When the market falls, the debt portion acts as a cushion preventing deep erosion of the portfolio value. Of course, when the market rises, these funds won’t rise as much as a pure equity fund. Since the asset allocation is already done in a single fund, it helps because the investor doesn’t have to worry about the allocation himself. Additionally, there are several variants of hybrid funds, which essentially are variants of the above. The mix of equity and debt would vary as per the scheme.
Low Risk Funds
The realm of investing can be quite confusing to new investors and this is why, before making a move in this direction, you should get your facts right and do some research beforehand. Always consult a financial advisor for help, when needed.
If your investment horizon is of less than three years, you should steer clear of equity-oriented funds altogether. You should opt for short term or medium term bond funds to avoid unnecessary exposure to risk in the shorter term.