Mutual Funds have gradually evolved into one of the most preferred investment instruments for many investors. The prime reason behind this rising prominence is that mutual funds have something to offer for all kinds of investors, across varying risk appetites and investment horizons. However, amongst the various categories of mutual funds, one category which remains immensely popular due to its potentially higher returns, is equity mutual funds.?
Let us understand the entire gamut of equity mutual funds in order to make an informed decision before stepping them into your investment portfolio and also maximize their potential and benefits as well.
As the name suggests, equity mutual funds pool in the money of various investors and predominantly invest the amount into the shares of different companies.? Funds that invest at least 65% of their total asset into equity or equity-oriented securities, are deemed as equity-oriented funds. Equity mutual fund managers aim to offer high returns by diversifying and spreading the investments across various companies from different sectors or with varying market capitalizations, such as large cap or small cap. Typically, equity mutual funds are known to have historically been generating higher returns than other investment vehicles like fixed deposits or debt-based funds. Remember that, as these funds’ performance depends on market dynamics, the element of risk tends to be higher. However, the degree of volatility is higher in the short term and lower over the long term.
Equity mutual funds especially work well for those investors who wish to benefit from the high potential returns of equities without the direct purchase of stocks. This holds especially true for new investors who lack knowledge and expertise to directly invest in stocks and/or do not have time to track market movement regularly. Hence, instead of directly taking partial ownership of a company through purchase of stocks, one can go for equity mutual funds route to invest in equities. Led by professional fund managers, equity mutual funds pool in the money collected from investors, invest them in diversified securities and manage an optimum portfolio to minimize risk and maximize returns.
There are multiple ways to categorize equity mutual funds. Let us deep dive and understand these categorizations:
Investment Strategy-based Categorisation
Theme and Sectoral Funds – Equity mutual funds can decide to follow a particular investment theme such as an international stock theme or emerging market theme, for investment. Whereas some schemes may invest in a specific sector of the market such as IT, BFSI, Pharmaceutical, etc. Since theme or sector based funds focus on a particular sector or theme, they tend to involve a higher degree of risk.
Focused Equity Funds – These equity funds invest in at least 30 stocks of companies having market capitalization as specified at the time of the launch of that scheme.
Contra Equity Funds – Similar to what its name suggests, these funds tend to follow a contrarian strategy for investment. These funds analyse the market in order to identify the under-performing stocks and then purchase them at low prices under the assumption that these stocks will go on to recover in the long term.
Market Capitalization-based Categorization-?
Based on which companies the schemes decide to invest in as per the market capitalization, these are the types of equity mutual fund schemes:
Large-Cap Funds – These funds typically make an investment of at least 80% of their total assets into the equity shares of the top 100 companies in terms of full market capitalization.?
Mid-Cap Funds – These funds typically make an investment of at least 65% of their total assets into the equity shares of 101-250th placed companies in terms of full market capitalization.?
Small-Cap Funds – These funds typically make an investment of at least 65% of their total assets into the equity shares of 251st onwards placed companies in terms of full market capitalization.
Multi-Cap Funds – These funds typically make an investment of at least 65% of their total assets into the equity shares across large-cap, mid-cap and small-cap companies in varying proportions.?
Large and Mid-Cap Funds – These funds typically make an investment of at least 35% of their total assets into the equity shares of both mid-cap companies and large-cap companies.?
In September 2020, SEBI had diversified the underlying investments of Multi cap funds across large, mid and small cap companies by partially modifying the scheme characteristics and making it mandatory for fund houses to make a minimum investment of 25% of total assets into large, mid, and small companies each. As a next step to provide more flexibility to mutual funds, SEBI altogether introduced a new category under equity schemes, named Flexi cap funds in November 2020, which has to make an investment of at least 65% of total assets into equity and equity related instruments, with investment across large, mid, and small cap companies.
All equity funds barring ELSS, are non tax saving schemes. As far as Equity Linked Savings Scheme (ELSS) is concerned, it is the only equity mutual fund scheme that offers tax benefits. Investment of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act can be claimed as tax deduction. ELSS funds have to invest at least 80% of their total assets into the equity and equity related instruments. Moreover, they have a mandatory lock in period of 3 years, before which the investors cannot redeem their investment.
Investment Style-based Categorization
Active Funds – These funds tend to be actively managed by the fund managers who decide to handpick the stocks wherein they want to invest into.
Passive Funds – These funds usually tend to? track a market segment or index which acts as the determinant for the list of stocks which the fund will invest into.Thus, the fund manager does not have an active role in the decision or selection of the stocks to invest into.
Taxation of Equity Mutual Funds- All equity schemes' returns are subject to capital gains tax.? Equity mutual funds levy 15% rate of tax on short term capital gains, i.e. gains on redeeming your equity funds within a holding period of less than 1 year. Whereas gains realized on redeeming your equity fund units on or after 1 year are termed as long term capital gains (LTCG). While LTCG upto Rs 1 lakh a year are tax-exempt, gains above this limit get taxed at 10%.
Investors keen to invest in stocks but lack the expertise and/or time:?More often than not, many potential investors fail to begin investing in equities due to lack of expatriate and/or time. This is exactly where equity mutual funds can come to the rescue. For such categories of potential investors, equity mutual funds are the right opportunity to step into equity investments through the expertise and experience of fund houses and fund managers. The key to successful equity investing is choosing the right funds, investing regularly, and remaining invested for the long term.
Investors who can stay invested for a long term of 5 years and more: While equity mutual funds tend to be highly volatile in the short-term, they do hold immense potential to generate high returns over the long term of 5 years and above. Hence, for long term goals like retirement, child’s higher education/marriage corpus etc., equity funds are the most suitable investment vehicle to achieve these goals through returns that outperform both inflation and other asset classes by a wide margin over the long term.
Investors aiming to realize twin goals of tax saving and wealth creation: Equity-Linked Savings Schemes (ELSS) are tax saving mutual fund schemes. They aim to fulfill twin objectives for the investor-Wealth creation and Tax saving. As they invest a major proportion of their portfolio into equity or equity related instruments across different sectors, market capitalization etc., their returns usually outperform not just inflation but also the various fixed income investment options under section 80C, as well as other asset classes, by a wide margin over the long-term.? They involve a mandatory lock-in period of three years, and ELSS investments of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act can be claimed as tax deduction per financial year.
Equity mutual funds are different from debt mutual funds that invest in debt instruments.
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