Investment Series: If you want to know how mutual funds are classified, read this

The number of types or categories of mutual funds you will encounter can be overwhelming. It, therefore, helps to understand the basis on which these categories are created. There is also a hierarchy with sub-categories of categories. We won’t describe all of them, but take up the common ones.

Categorization is based on the investment asset class
This is the highest level of categorisation. There is some debate on how many Asset Classes there are but from a mutual fund investor’s perspective, the list comprises of:

• Cash
• Equities (or Stocks)
• Fixed Income (Bonds or Debt)
• Gold
• Commodities (Not available in India)
• Real Estate (Limited availability in India)

Equity Mutual Funds invest in equities; Debt funds invest in Fixed Income or Debt; Gold funds invest in Gold. There are also Hybrid Funds that invest in multiple asset classes – Equities and Debt for example.
Some funds invest in other funds. These are called fund of funds.

Types of Equity Funds
While all equity funds invest in stocks of listed companies, they differentiate by their focus or investment strategy. This is clearly identified in the Investment Objective of the scheme. We list them here in an approximate order of frequency in which you may encounter them.

• Based on the size of companies they invest in: Large Cap (Very large companies only), Mid-cap, Small-cap and Multi-cap
• Based on the sectors they invest in: Diversified (invest across sectors), Banking (only banks), Pharmaceuticals, Infrastructure, PSU etc.
• Based on Investment theme: High Dividend yield stocks; Emerging stocks; International stocks; Value investing
• Based on Investing Style: Index Funds invest in all the stocks comprising an “Index” such as the BSE Sensex or S&P Nifty in exactly the same proportion. These are also called “Passive Funds” because the investment style does not involve active stock selection.
• Quant funds use quantitative methods to select stocks rather than researching the underlying business of the company.

Types of Debt funds

• Based on duration of investments: Long-term debt funds invest in duration of one year or longer, liquid funds invest in duration of a few months.
• Based on how returns are given to you: Monthly Income Plans (MIPs) provide a regular income stream by distributing dividends.
• Based on category of debt the fund invests in: Gilt funds invest in government securities only

Equity and Debt funds can have additional categorizations

Based on how you invest in them
· Open-ended funds (most funds are like this) permit investors to invest and withdraw at any time.
· Closed funds have a fixed duration and you can only invest when the scheme is announced and withdraw when it ends.
· An interesting variation called Interval Funds open for subscription periodically.
· ETFs (Exchange Traded Funds) are listed on the stock exchange and provide an additional method of investing in them. Any fund can be an ETF. Unlike other mutual funds where the NAV is only published at the end of the day, these have market-determined prices (which may be different from NAV) at which you can buy and sell through the day. Most closed ended funds are also ETFs to ensure that investors have an option to exit before maturity.
· Regular Plans are distributed through intermediaries who provide additional services to investors. The cost of these services is recovered through slightly higher expenses for these plans.
· Direct Plans are purchased directly from the fund house and have lower expenses.

Based on how they return money to you
· Dividend plans will periodically return money to investors as dividends.

· Growth plans will keep the money invested until you choose to withdraw the amount you need.

The Next Lesson on this series will be: How to Select a Mutual Fund to invest in?

(About the author: This article has been contributed by Sanjiv Singhal, CEO, scripbox.com.)

(Image: Reuters)