Types of mutual funds
Rohit – “Yes, I’m finally starting to invest in mutual funds but there are many categories in mutual funds. which I need to choose ? where I need to invest? Why they are classified into different types ? Are Mutual funds are classified into different types based on risk, returns, and investment strategy?
If you are also confused about these questions – where to invest, how to pick funds in mutual funds and struck like Rohit after taking a decision. Then you are in the right place to understand about all the categories available in mutual funds, how they are classified and how to pick a fund.
Mutual funds are classified into majorly 4 types, each of these are again classified into other sub types.
- Equity
- Debt
- Hybrid
- Commodities
Let’s learn about everything in detail.
Equity Mutual funds
Equity mutual funds are divided into different sub-types. These are funds where the fund manager invests most of the money in equities (stocks). These funds are further classified into different sub-types. One major classification is based on company size, which includes three main categories:
Large cap : Large cap companies are classified based on market capitalization, and they include the top 100 companies in the market. The fund managers are allowed to invest 80% of fund money into large cap companies and 20% in other asset classes then only it is considered as large cap mutual funds.
Mid Cap : Mid cap companies are classified based on market capitalization, and they include companies ranked from 101 to 250 in the market. The fund managers are allowed to invest 65% of fund money into mid cap companies and the rest can be invested in other asset classes then only it is considered as mid cap mutual funds.
Small cap : Small cap companies are classified based on market capitalization, and they include companies ranked below 250 in the market. The fund managers are allowed to invest 65% of fund money into small cap companies and the rest can be invested in other asset classes then only it is considered as small cap mutual funds.
Large & Mid Cap Fund : Large & Mid Cap funds invest in both large cap and mid cap companies, providing a balance between stability and growth. In this fund, the fund manager has more choice of investing like he can put 35% of money in large cap, 35% of money in mid cap remaining 30% is manager choice can invest in small or other assets classes.
Multi Cap Fund : Multi Cap funds invest in large cap, mid cap, and small cap companies, ensuring diversified exposure across all market capitalizations.” This is the most balanced allocation rule in mutual funds that fund managers need to put 25% into each category: large – 25%, mid – 25%, small – 25% and remaining in other asset classes.
Flexi Cap Fund : Flexi Cap funds invest across large cap, mid cap, and small cap companies, with the flexibility to adjust allocations based on market conditions. This fund gives more freedom to the fund manager. The fund manager can invest 65% of a portion of money into any category (Large, Mid, Small) remaining in other asset classes..
Debt Mutual Funds
Debt mutual funds are divided into different sub-types. These are funds where the fund manager invests most of the money in fixed income instruments like bonds, treasury bills, and other debt securities. These funds are further classified into different sub-types. One major classification is based on investment duration and credit quality, which defines risk and return in these funds.
“Based on Duration” (Time)
Overnight Fund : In Overnight Fund, fund managers invest all the fund amount in debt instruments that mature in one day.
Liquid Fund : In Liquid Fund, the fund manager needs to invest the fund amount for 91 days in debt instruments, which is considered as short term parking or emergency funds.
Ultra Short Duration Fund : In Ultra short duration funds, the fund manager needs to invest the fund amount for a period of around 3 to 6 months in debt instruments.
Low Duration Fund : In Low duration funds, the fund manager needs to invest the fund amount for a period of around 6 to 12 months in debt instruments, which is considered as balancing stability and returns.
Short Duration Fund : In Short duration funds, the fund manager needs to invest the fund amount for a period of around 1 to 3 years in debt instruments. This Fund offers decent returns historically.
Medium Duration Fund : In Medium duration funds, the fund manager needs to invest the fund amount for a period of around 3 to 4 years in debt instruments. This Fund offers decent returns historically and needs to consider interest rate changes to start having a noticeable impact.
Medium to Long Duration Fund : In Medium to long duration funds, the fund manager needs to invest the fund amount for a period of around 4 to 7 years in debt instruments. This Fund offers decent returns historically and needs to consider interest rate changes to start having a noticeable impact.
Long Duration Fund : Long duration funds invest in long-term debt instruments. The fund manager maintains a duration of more than 7 years, making these funds highly sensitive to interest rate changes.
“Based on Credit Quality & Strategy“
Corporate Bond Fund : In this Fund the fund manager needs to invest 80% of money in high-rated corporate bonds means AA+ and above and fund managers need to invest money only in bonds issued by companies with high credit ratings.
Banking & PSU Fund : In this Fund the fund manager need to invest 80% of money in banking and PSU securities, providing stability and reliability and fund managers need to invest money only in bonds issued by banks and government-owned institutions
Gilt Fund : Gilt funds invest in government securities. The fund manager invests at least 80% in government bonds, making them free from default risk but exposed to interest rate risk.
Credit Risk Fund : In this Fund the fund manager needs to invest 65% of money in lower-rated instruments below AA and fund managers invest money in lower-rated instruments to generate high returns.
Dynamic Bond Fund : This gives full freedom to the fund manager to adjust their instrument duration based on interest rate movements and fund managers have full comfort to change duration, depending on the market conditions and interest rates.
Floater Fund : Floater funds invest in instruments with floating interest rates. The fund manager invests at least 65% in floating rate instruments, where returns change with interest rates.
Fixed Maturity / Target Maturity Fund : Here in this fund the fund manager can hold the bond or instrument till the mature period and fund manager invest in bonds that mature at a fixed time.
Relationship between interest rates change and debt mutual funds
The Important thing needed to discuss is the relation between interest rates change and debt mutual funds. If you understand this you will get clear picture about debt mutual funds and their sub-types.
The relationship between interest rates and debt fund returns is inversely proportional.
- If interest rates go up, debt fund values go down
- If interest rates go down, debt fund values go up
Why does this happen?
In general, money is mainly invested in bonds only in debt funds, so bonds offer fixed interest rates.
Scenario 1: Interest Rates Increase if old bond interest rate is 7% then new bonds interest rates increase in the market to 9%.
What do investors do – They prefer 9% bonds rather than 7% interest rate bonds. So, investor start exiting from old bonds then old bond value decreases (price falls)
Result: Debt fund value decreases
Scenario 2: if old bond interest rate is 7% then new bonds interest rates decrease in the market to 5%.
What do investors do – 7% bonds become more attractive and new investors will not show interest in buying less interest rate bonds already holding investors try to average more or hold. So, demand increases automatically Price increases.
Result: Debt fund value increases
“Interest rates and bond prices move in opposite directions. This is why debt fund values rise when interest rates fall and fall when interest rates rise.”
Hybrid Mutual funds
In Hybrid mutual funds, fund managers can invest both equity and debt funds in fixed percentage by Sebi. Again these hybrid mutuals are classified into other sub categories.
Aggressive Hybrid : In Aggressive Hybrid Mutual funds 65% to 80% money is invested in Equity and remaining is invested in Debt funds, defines that majority is exposed to equity and growth is high with stable fixed debt returns. Risk is also high because of high exposure to equity.
Balanced Hybrid : In Balanced Hybrid mutual funds, the fund amount is equally distributed in both equity and debt funds to achieve decent and relatively stable returns historically.
Conservative Hybrid : In Conservative Hybrid mutual funds, the fund amount is majorly distributed into debt funds around 75% to 90% in debt and remaining in equity which reflect that this funds focus safety more than returns with very little exposure to risk.
Dynamic Asset Allocation : Dynamic Asset Allocation is also referred as a balanced advantage fund where there is no fixed percentage to invest, fund managers invest dynamically depending on the market.
Example:
- Market high → equity reduce
- Market low → equity increase
Multi Asset Allocation : A multi-asset allocation fund invests in at least three different asset classes, with a minimum of 10% in each. For example, it may allocate 10% to equity, 10% to debt, and 10% to commodities. This diversification helps reduce risk and provides better stability during market downturns.
Equity Savings : The combination of Equity + Arbitrage + Debt is referred as Equity Savings fund, in fund amount Minimum 65% need to invest in Equity related (including arbitrage) remaining need to invest in Debt this defines stable returns.
Commodity Equity Funds
Generally commodities are very volatile, in commodity mutual funds are 2 major sub categories
- Gold mutual funds – Money is invested only in gold bonds.
- silver mutual funds – Money is invested only in silver bonds.
Why are mutual funds classified into different categories
As people have different mentality and mindset, one person need profit and accept loss equally, Different investors have different financial goals, risk tolerance, and investment preferences.
Note: The returns in mutuals are not guaranteed; they depend on personal investment choice and the person who manages your money. Mutual funds returns are also taxable based on the returns and time period of hold one can be classified in their respective tax slab.
Conclusion
Picking the correct fund according to your personal goals is the first one should need to do, mutual funds are classified into categories and sub categories based on risks, holding period and asset classes.
TO LEARN ABOUT READ What is mutual funds.
FAQs About Types of Mutual Funds
Which type of mutual fund is best for beginners?
Hybrid funds, index funds, and balanced mutual funds are commonly considered beginner-friendly because they provide diversification and moderate risk exposure.
What is the safest type of mutual fund?
Debt mutual funds and liquid funds are generally considered lower-risk mutual fund categories compared to equity funds.
Which mutual fund has highest returns?
Equity mutual funds have historically generated higher long-term returns, but they also carry higher market risks.
What is the difference between equity and debt mutual funds?
Equity mutual funds invest mainly in stocks, while debt mutual funds invest mainly in bonds and fixed-income securities.
Can beginners invest in mutual funds with ₹100?
Yes, many mutual funds in India allow beginners to start SIP investments with as little as ₹100.
