Types of Mutual Funds: Categories and Sub-Categories, Who should invest in which Mutual Fund and Taxation

Retail Mutual Fund Investors are rising rapidly in India. In March 2024, there were 17.8 crore mutual fund accounts, out of these 91.4 percent were those of retail investors as per the Association of Mutual  Funds of India (AMFI). Retail investors are those who have a ticket size of less than Rs.2 lakhs. In this scenario, understanding the types of mutual funds has become more important for investors to diversify their portfolio and reduce the risk. 

But first, let's discuss what Mutual Funds are. A mutual fund is formed when an asset management company (AMC) pools money from several individual and institutional investors to purchase securities such as stocks, debentures and other similar assets. The AMCs have fund managers to manage the pooled investment. Fund units assigned to Mutual fund investors corresponding to their quantum of investment. Investors are allowed to purchase or redeem fund units only at the prevailing net asset value (NAV).

The NAV of mutual funds varies daily depending on the performance of the underlying assets. Mutual funds are well regulated by the Securities and Exchange Board of India (SEBI). A significant advantage of investing in mutual funds is that investors can diversify their portfolios at a relatively lower investment amount.

Mutual funds are broadly classified into Equity Funds, Debt Funds, Hybrid Funds, Solution Oriented Funds and other schemes (Index Funds and Funds of Funds). Based on the underlying assets these funds are categorised. Like Equity Mutual Funds majorly invest in equities, Debt Mutual Funds majorly invest in debt instruments and Hybrid Mutual Funds majorly invest across both equity and debt securities. These major categories have some sub-categories, which are based on their exposure to equities.

Other than the types of mutual funds, on this page, we have also discussed the other aspects of mutual funds like Who should invest in which funds, consideration points before investing and taxation on mutual funds.

Types of Mutual Funds

Here are the major categories and sub-categories of Mutual Funds.

Types of Equity Mutual Funds

 

Equity mutual funds invest at least 65% of their assets in equity and equity-related instruments. These funds aim for high returns by capitalizing on the growth potential of these companies. The value of investments can fluctuate due to market conditions. Equity mutual funds can be sector-specific, diversified, or thematic, providing various options based on investors' risk appetite and investment goals.

Large Cap Mutual Funds

As the name suggests, Large cap funds invest in large listed companies, the top 100 companies according to market capitalisation. These companies are market leaders in their respective industries like Reliance, TCS, Infosys, Bharti Airtel, HDFC etc. Large cap funds have to invest a minimum of 80% of their assets in equity and equity related instruments of large cap companies. How much they want to invest in which large stock is decided by the fund's strategy. Due to their major exposure to big companies, large cap funds are considered less riskier and more stable. 

Mid Cap Mutual Funds

These Funds buy stocks of top companies between 101 to 250 according to market capitalisation. Mid cap companies have a market capitalisation between Rs.5000 crore to Rs.20000 crore. These companies have a higher potential to grow. Currently, some of these companies are Hitachi Energy India, Bank of Maharashtra, Suzion Energy, Blue Star, etc. Mid cap funds have to invest a minimum of 65% of their assets in equity and equity related instruments of mid cap companies. Mid cap funds are considered more riskier than large cap funds but have chances to surpass the returns of the latter. An average annual return of mid cap funds is 26.95%, as mentioned on ET money. 

Small Cap Mutual Funds 

Stocks of small companies are the major underlying assets of small cap funds. These companies have a market capitalisation of less than Rs.5000 crore. They have a high growth potential but also a lot of risk is aligned with them. SEBI says all the companies ranked from 251 onwards in terms of market capitalisation are by default becoming part of small cap companies. JK laxmi cement, Lux Industries, Edelweiss, Birla corp, etc. Small cap funds have to invest a minimum of 65% of their assets in equity and equity related instruments of small cap companies. Small cap funds can deliver fantastic returns but at the same time, the chances of volatility are very high.  

Large and Mid Cap Funds

These Funds are blend of large and Mid cap stocks. Instead of investing their major amount of money in one category of stocks, Large and Mid cap funds distribute their asset according to the following strategy: a minimum of 35% of assets invested in large cap stocks and a minimum of 35% invested in mid cap stocks. These funds expect to provide returns higher than large cap funds, but less risky than mid and small cap funds. 

Multi Cap funds

There is no restriction on multi cap funds to follow an investment strategy which is confined to specific market capitalisation. These funds invest in any company’s stock irrespective of market capitalisation and diversify their portfolio. Any stock can be a part of their investment portfolio, not matter If it belongs to a large cap company or small cap company. This freedom allows them to make necessary changes in their investment portfolio as the market demands. The only one thumb rule for them is that they have to invest a minimum of 65% of their assets in equities and equity related instruments.

Focused Mutuals Funds

Usually, stocks of 70-80 companies lie under a mutual fund scheme, but this is not the case with Focused Mutual Funds. These funds can purchase stocks of up to 30 companies. Fund managers studiously go through each company’s details before investing. They make a concentrated portfolio with limited stocks, so they can give their maximum attention to each lying asset and grow the investment as much as they can while managing the risk. According to SEBI’s rule, Focused Funds have to invest a minimum of 65% of their assets in equities and equity related instruments.

Dividend Yield Funds 

These funds do not go by their name, they are not under any obligation to pay dividends at regular intervals, which is the opposite of the image we build when we read dividend yield funds. Investing in a kind of companies that payout dividends comparatively with high frequency is a strategy they follow, this is the reason they are called dividend yield funds. Investors of a dividend yield fund receive dividend income consistently and get the benefit of regular income while letting their investment also grow lying in the fund. These funds can also diversify their portfolio since they are obliged to invest a minimum of 65% of their corpus into equity and equity related instruments, while 35% gives them space for different bets. 

ELSS Mutual Funds

Equity Linked Savings Scheme Mutual Funds can be decoded by reading the name only. These funds invest a minimum of 80% of their corpus in equity and equity linked instruments and also provide tax benefits like saving schemes. ELSS funds have a lock-in period of 3 years, LTCG (long term capital gain tax) is applicable on the withdrawal after the lock-in period, which is 10% (on above 1 lakh) without indexation benefit. ELSS allows investors to take a tax deduction of up to Rs.1,50,000 on their investment under section 80(c) of the income tax act. 

Types of Debt Mutual Funds

 

Debt mutual funds invest in fixed income instruments like bonds, government securities, and money market instruments. These funds aim to provide stable returns and preserve capital. Interest rate changes impact their performance. Debt funds are often chosen by conservative investors or those nearing financial goals. 

Liquid Mutual Funds  

Liquid Mutual Funds invest in debt instruments which have a maturity period of up to 91 days, like Treasury bills issued by the government and Commercial Papers issued by corporate entities. According to these debt instruments, investors will get back the money after the agreed period and meanwhile, issuers will pay them interest, which is also called coupon rate. It is like giving a loan and getting interest on the lending amount. Before investing the money mutual fund houses review the credit rating of the issuer company, which is equivalent to a credit score of an individual. A high credit rating is a sign of a company's good financial health. Liquid Funds have to invest 20% of their corpus in high liquid options (cash or cash equivalent instruments or money market instruments) to meet the redemption demand of investors.

Overnight Mutual Funds 

As liquid funds invest in debt options with a maturity period of up to 91 days, overnight funds invest in securities that mature in a 24 hours window. This security is called Tri-party-repo or Trep and is regulated by the Reserve Bank of India.  Due to this one day maturity window, credit risk is very low. 

Ultra Short Duration Funds

Ultra short duration funds invest in short term securities and money market instruments, ensuring to maintenance of the fund's portfolio Macaulay Duration of 90 to 180 days. Macaulay Duration is the average maturity duration of underlying securities of a fund scheme. In easy language, it is the time taken by investors (mutual fund houses) to recover the invested money after considering the interest payments. 

Low Duration Funds

According to SEBI, low duration funds invest in debt instruments with a maturity period between 6 to 12 months. These debt instruments are commercial paper by corporations, certificates of deposit by banks and Treasury bills issued by the government. Credit risk is higher than the liquid funds, overnight funds and ultra short funds due to longer macaulay duration than the mentioned funds.  

There are other duration funds like short duration funds, medium duration funds and long duration funds that invest in different debt instruments in a way that they can maintain macaulay durations defined by SEBI for these funds.