Right since its inception, Mutual Funds have evolved into a preferred investment tool for many investors. However, choosing the right Mutual Fund scheme can be a difficult task due to the wide array of options available. Investment requires a careful and well-thought approach to avoid potential losses. Hence, it is imperative to understand the basics of the different types of schemes available to you. Here, we will explore Equity Mutual Funds and talk about the different types of equity funds along with their benefits and a lot more.
In this article
- What are Equity Funds?
- Types of Equity Mutual Funds?
- How Does an Equity Mutual Fund work?
- How should you invest in an Equity Mutual Fund?
- Features of an Equity Fund
- Benefits of investing in Equity Mutual Funds
- Taxation rules of Equity Funds?
- Choosing between Lumpsum Investment and SIP
What are Equity Funds?
As the name suggests, Equity Funds invest in the shares of different companies. The fund manager tries to offer great returns by spreading his investment across companies from different sectors or with varying market capitalizations. Typically, equity funds are known to generate better returns than term deposits or debt-based funds. There is an amount of risk associated with these funds since their performance depends on various market conditions.
Types of Equity Mutual Funds?
There are various ways of categorizing equity funds. Here is a look at the different categorizations:
Investment Strategy-based Categorization
- Theme and Sectoral Funds – An Equity Fund might decide to follow a specific investment theme like an international stock theme or emerging market theme, etc. Also, some schemes might invest in a particular sector of the market like BFSI, IT, Pharmaceutical, etc. Here, it is important to note that sector or theme-based funds carry a higher risk since they focus on a specific sector or theme.
- Focused Equity Fund – This fund invests in a maximum of 30 stocks of companies having market capitalization as specified at the time of the launch of the scheme.
- Contra Equity Fund – As the name suggests, these schemes follow a contrarian strategy of investing. These schemes analyze the market to find under-performing stocks and purchase them at low prices under the assumption that these stocks will recover in the long term.
Market Capitalization-based Categorization
Some schemes might decide to invest in companies with specific market capitalizations only. Here are the common types:
- Large-Cap Funds – which typically invest a minimum of 80% of their total assets in equity shares of large-cap companies (the top 100). These schemes are considered to be more stable than the mid-cap or small-cap focused funds.
- Mid-Cap Funds – which usually invest around 65% of their total assets in equity shares of mid-cap companies (101-250th placed companies according to market capitalization). These schemes tend to offer better returns than the large-cap schemes but are also more volatile than them.
- Small-Cap Funds – which typically invest around 65% of their total assets in equity shares of small-cap companies (251st and below placed companies according to market capitalization). This is a huge list and more than 95% of all companies in India fall into this category. These schemes tend to offer great returns than the large-cap and mid-cap schemes but are also highly volatile.
- Multi-Cap Funds – which usually invest around 65% of their total assets in equity shares of large-cap, mid-cap and small-cap companies in varying proportions. In these schemes, the fund manager keeps rebalancing the portfolio to match the market and economic conditions as well as the investment objective of the scheme.
- Large and Mid-Cap Funds – which usually invest around 35% of their total assets in equity shares of mid-cap companies and 35% in large-cap companies. These schemes offer a great blend of lower volatility and better returns.
Tax Treatment – Based Categorization
- Equity Linked Savings Scheme (ELSS) – ELSS Funds is the only equity scheme which offers tax benefits of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. These schemes invest a minimum of 80% of its total assets in equity and equity related instruments. Further, these schemes have a lock-in period of 3 years.
- Non-Tax Saving Equity Funds – Except ELSS, all other Equity Funds are non-tax saving schemes. This means that the returns are subject to capital gains tax.
Investment Style-based Categorization
- Active Funds – These schemes are actively managed by the fund managers who handpick the stocks that they want to invest in.
- Passive Funds – These schemes usually track a market index or segment which determines the list of stock that the scheme will invest in. In these schemes, the fund manager has no active role in the selection of the stocks.
How Does an Equity Mutual Fund work?
A Mutual Fund scheme is classified as an Equity Mutual Fund if it invests more than 60% (sixty percent) of its total assets in the equity shares of different companies. The balance amount can be invested in money market instruments or debt securities as per the investment objective of the scheme. Further, the fund manager can choose to invest in a growth-oriented or value-oriented manner and select companies according to his assessment of the investment generating maximum returns.
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How should you invest in an Equity Mutual Fund?
Like any other investment decision, you must assess your financial goals, risk tolerance, and investment horizon carefully before signing the dotted line. For the sake of understanding, we have divided the investors into two broad categories – the new entrants and seasoned investors.
If you are investing in Equity Funds for the first time…
Many new investors are wary of investing in the capital market since they have little capital to invest (young investors) or lack time to constantly monitor their investments (a must for share investments) or lack the expertise to choose the right shares. Hence, they turn to equity mutual funds. However, there are many types of equity funds available and choosing the right one can still be a challenge. We recommend most new investors to opt for Large-Cap Equity Funds. These schemes typically invest in the shares of the best companies in the market and have a history of generating consistent returns.
If you are a seasoned investor…
There is nothing much that we can say that you don’t already know! However, we recommend you to opt for diversified equity funds and take calculated risks. Your understanding of the market can help you choose the right scheme and earn higher returns as compared to other equity funds.
Features of an Equity Fund
Here are some salient features of Equity Mutual Funds in India:
Lower Expense Ratio
In an Equity Fund, regular buying and selling of shares can lead to an increase in the expense ratio of the scheme. The Securities and Exchanges Board of India (SEBI) has created an upper limit for the expense ratio of equity funds at 2.5%. Also, SEBI might reduce it further. This means more returns for investors.
Tax Exemption under Section 80C
The Equity Linked Savings Scheme or ELSS offers tax exemption under Section 80C of the Income Tax Act with exposure to equity. It has a small lock-in period of 3 years and offers great potential for earning good returns. You can also invest in an ELSS in installments.
Equity Funds allow you to gain exposure to several good equity shares by investing a small amount. Hence, your equity portfolio is diversified and offers a better opportunity of earning good returns.
Benefits of investing in Equity Mutual Funds
Equity Funds allow you to invest in the capital market without having to worry about choosing individual stocks or sectors. Traditionally, investors with a sound knowledge of the market would earn great returns in the equity market. However, Equity Mutual Funds employ expert fund managers to research for you. Here are some advantages of investing in Equity Funds:
- Your investment is managed by experts
- It is cost-efficient
- It offers diversification
- You can opt for systematic investments (installments)
- It offers flexibility and liquidity
Taxation rules of Equity Funds?
In the case of Equity Funds, the taxation rules are as follows:
Capital Gains Tax
If you hold the units of the scheme for a period of up to one year, then the capital gains earned by you are called short-term capital gains or STCG. STCG is taxed at 15%.
If you hold the units of the scheme for more than one year, then the capital gains earned by you are called long-term capital gains or LTCG. LTCG above Rs.1 lakh is taxed at 10% without indexation benefits.
Dividend Distribution Tax (DDT)
This tax is deducted at source. Hence, when the mutual fund pays out dividends, it deducts DDT of 10% before distributing the dividend.
Choosing between Lumpsum Investment and SIP
When you decide to invest, apart from other choices, a big question faced by you is choosing between a lump sum and SIP investment plan.
Lumpsum investment means that you invest the entire amount together. For example, if you want to buy units worth Rs. 5 lakh, then you can debit your bank account by the said amount and purchase the units. On the other hand, an SIP or Systematic Investment Plan means that you invest a fixed amount of money at regular intervals.
Both lumpsum and SIP investing have their pros and cons. A lumpsum investor needs to invest at the right time to earn good returns. The risk is that if he times it wrong, then the returns can be lesser or he might even book losses. SIP investing helps mitigate this risk by allowing you to invest the same amount spread across a large period. This makes SIP investing affordable and flexible while inculcating the habit of investment discipline in you. Further, SIP investing also helps you benefit from Rupee Cost Averaging (RCA) where the average cost of purchasing a single unit reduces with time and you are safeguarded from market fluctuations.
An Overview of Equity Funds in India
Generally, Equity Funds are known to deliver around 10-12% returns (pre-tax). This is an average figure and the performance of every fund can vary depending on the market conditions. Choosing the right scheme goes a long way in helping you ensure healthy returns on your investment. Based on the returns of the last five years, here is a list of equity funds which have been the best performers: