If you've ever tried learning a new language, you know how tough it can be at first to wrap your tongue around the new, unfamiliar words. But over time, you get comfortable, and soon, you're rattling off entire sentences without pause. For those uninitiated in mutual funds, understanding the different types of funds, and the related terminologies, can be as confusing as learning a new language. Therefore, in this article, we've explained six common mutual fund types, and how each of them is distinctive in terms of their structure, risk profile or investment approach.
1. Open and closed-ended funds
When a new fund is launched, the fund house issues a New Fund Offer (NFO). And therein lies the main difference between open and closed-ended funds. Open-ended fund units can be bought any time after the NFO by an investor, at the prevailing NAV rate. The fund house will issue new units as per the demand. Existing investors can also sell their units any time. In contrast, a closed-ended fund only issues a fixed number of units at the time of NFO, and fresh units cannot be purchased thereafter. Investors in a closed-ended fund must wait for the scheme to end before they can sell their units (unless the scheme is listed on the stock exchange, in which case it can be traded there).
2. Equity, Debt and Balanced funds
In simple terms, equity funds invest in the stock markets, while debt funds invest in debt market instruments such as government securities, bonds or treasury bills. Balanced funds go for a combination of the two.
3. Large, mid and small-cap funds
The term 'cap' refers to capitalisation, or the total value of a company's shares that are traded on the exchange. A large-cap fund is one that invests in companies with significantly large market capitalisation. Similarly, mid and small cap funds invest in firms whose market capitalisation is in the middle or lower range. Most mutual funds invest in a mix of small, mid and large-cap funds.
4. Thematic or sectoral funds
The terms 'thematic' or 'sectoral' explain the respective investment focus or philosophy of a fund. If a fund is thematic, it invests in sectors matching that theme. For example, an infrastructure fund could invest in sectors like steel, roads, telecom, oil, or cement, because all these come under the term 'infrastructure'. Sectoral funds have a narrower focus and focus on a specific sector, such as banking, pharma or auto. As you can guess, because of lower diversification, sectoral funds are more prone to upswings or downswings.
5. Exchange traded funds
ETFs are similar to mutual funds, but with some differences. ETFs can be freely bought and sold on the stock exchanges, and their composition mirrors that of an index (like the BSE or NSE), commodity or basket of securities. Each share of an ETF represents ownership of the underlying commodity or security. One popular example is gold ETFs, which are backed by physical gold, and give investors the freedom to trade in the precious metal without having to hold physical reserves of gold themselves.
6. Fund of Funds
Believe it or not, there are mutual funds that invest in other funds. These funds might be run by the same asset management company, or by other AMCs, based in India or abroad.
We hope the above guide helped you get an insight into the common types of mutual funds. Mutual funds are highly diverse and offer you a wide range of choices. This is what makes them so appealing to investors of all kinds. For more information, check out the recent 'Mutual Funds Sahi Hai' campaign by The Association of Mutual Funds in India (AMFI).
Mutual fund investments are subject to market risks, read all scheme related documents carefully.