Decoding Mutual Fund Categories: A Comprehensive Guide

 

Decoding Mutual Fund Categories: A Comprehensive Guide

Mutual funds have long been favored by investors as a means to diversify their portfolios, generate wealth, and meet financial goals. To provide clarity and transparency in the mutual fund universe, the Securities and Exchange Board of India (SEBI) introduced guidelines on the categorization and rationalization of mutual fund schemes in October 2017. In this guide, we will explore the SEBI-defined mutual fund categories, their investment objectives, and the intricate world of mutual fund taxation.

SEBI's Classification of Mutual Fund Schemes

SEBI's guidelines have streamlined mutual fund schemes into five broad categories:

1. Equity Schemes
2. Debt Schemes
3. Hybrid Schemes
4. Solution-Oriented Schemes (For Retirement and Children)
5. Other Schemes (Index Funds & ETFs and Fund of Funds)

These categories help investors choose funds that align with their financial objectives and risk tolerance. Let's dive into each category's specifics:

Equity Schemes

Equity schemes primarily invest in stocks and equity-related instruments. They aim for long-term growth but can be volatile in the short term. These are suitable for investors with a higher risk appetite and longer investment horizons. Equity schemes are further classified based on their market cap and investment styles:

• Multi-Cap Fund: Invests at least 65% in equity and equity-related instruments.

• Large Cap Fund: Allocates at least 80% to large-cap stocks.

• Large & Mid Cap Fund: Invests at least 35% in large-cap and 35% in mid-cap stocks.

• Mid Cap Fund: Puts at least 65% into mid-cap stocks.

• Small Cap Fund: Invests at least 65% in small-cap stocks.

• Dividend Yield Fund: Focuses on dividend-yielding stocks, with at least 65% in such stocks.

• Value Fund: Adheres to a value investment strategy, with at least 65% in stocks.

• Contra Fund: Follows a contrarian investment strategy with at least 65% in stocks.

• Focused Fund: Concentrates on a limited number of stocks (maximum 30) with at least 65% in equity and equity-related instruments.

• Sectoral/Thematic Fund: Puts at least 80% into stocks of a particular sector/theme.

• ELSS (Equity Linked Savings Scheme): Invests at least 80% in stocks as per Equity Linked Saving Scheme, 2005, notified by the Ministry of Finance.

Sector-specific and thematic funds focus on specific industries or themes within the market, while value funds emphasize undervalued stocks.

Debt Schemes

Debt schemes primarily invest in bonds and other debt securities. They are suitable for investors seeking regular income with lower volatility than equities. Debt schemes encompass various types:

• Overnight Fund: Invests in overnight securities with a maturity of 1 day.

• Liquid Fund: Holds debt and money market securities with maturities of up to 91 days.

• Ultra Short Duration Fund: Invests in debt and money market instruments with a Macaulay duration between 3 and 6 months.

• Low Duration Fund: Allocates to debt and money market instruments with a Macaulay duration between 6 and 12 months.

• Money Market Fund: Invests in money market instruments with maturities of up to 1 year.

• Short Duration Fund: Puts money into debt and money market instruments with a Macaulay duration between 1 and 3 years.

• Medium Duration Fund: Invests in debt and money market instruments with a Macaulay duration between 3 and 4 years.

• Medium to Long Duration Fund: Allocates to debt and money market instruments with a Macaulay duration between 4 and 7 years.

• Long Duration Fund: Invests in debt and money market instruments with a Macaulay duration greater than 7 years.

• Dynamic Bond Fund: Alters the portfolio's tenor based on interest rate expectations.

• Corporate Bond Fund: Invests a minimum of 80% in AA+ and above-rated corporate bonds.

• Credit Risk Fund: Puts a minimum of 65% into AA and below-rated corporate bonds.

• Banking and PSU Fund: Allocates a minimum of 80% to debt instruments of banks, Public Sector Undertakings (PSUs), Public Financial Institutions (PFIs), and Municipal Bonds.

• Gilt Fund: Invests a minimum of 80% in government securities across maturities.

• Gilt Fund with 10-year Constant Duration: Focuses on government securities to match a Macaulay duration of 10 years.

• Floater Fund: Invests a minimum of 65% in floating-rate instruments.

Debt schemes cater to income generation and capital preservation. Investors must assess the tenor of the securities to determine return and risk.

Hybrid Schemes

Hybrid schemes invest in both equities and debt securities, aiming to balance growth and income. SEBI classifies hybrid schemes into seven sub-categories:

• Conservative Hybrid Fund: Allocates 10-25% to equity and equity-related instruments and 75-90% to debt instruments.

• Balanced Hybrid Fund: Puts 40-60% in equity and equity-related instruments and 40-60% in debt instruments.

• Aggressive Hybrid Fund: Allocates 65-80% to equity and equity-related instruments and 20-35% to debt instruments.

• Dynamic Asset Allocation or Balanced Advantage Fund: Manages investments dynamically between equity (0-100%) and debt (0-100%).

• Multi Asset Allocation Fund: Invests in at least three asset classes with a minimum 10% allocation in each.

• Arbitrage Fund: Follows an arbitrage strategy with a minimum 65% investment in equity and equity-related instruments.

• Equity Savings: Combines equity and equity-related instruments (min. 65%), debt instruments (min. 10%), and derivatives (minimum, for hedging specified in the SID).

Hybrid funds provide a balance between growth and stability, with the proportion of equity and debt indicated in the Scheme Information Document (SID).

Solution-Oriented & Other Funds

Solution-oriented schemes cater to specific financial goals:

• Retirement Fund: Requires a lock-in for at least 5 years or until retirement, whichever is earlier.

• Children’s Fund: Involves a lock-in for at least 5 years or until the child reaches the age of majority, whichever is earlier.

Additionally, there are other types of schemes:

• Index Funds/ETFs: Invest a minimum of 95% in securities of a particular index.

• Fund of Funds (Overseas/Domestic): Invest a minimum of 95% in the underlying fund(s).

• Gold Exchange Traded Funds (FoF): ETFs with gold as the underlying asset.

• International Funds: Enable investments in markets outside India.

International funds provide diversification and access to global markets, although they come with their own set of risks.

Taxation of Mutual Funds

Understanding the tax implications of mutual fund investments is crucial:

• Equity Mutual Funds: Become eligible for long-term capital gains taxation once they have held for a year. They incur a 10% tax on profits exceeding the initial one lakh. Any gains realized before the one-year mark will be subject to a 15% tax, classified as a short-term capital gain.

• Debt Funds: Taxed as short-term capital gains (as per income slab) irrespective of the time holding of units.

In conclusion, SEBI's categorization of mutual fund schemes simplifies investment choices for individuals. Each category aligns with specific financial goals, risk tolerance, and investment horizons. Understanding these categories and their taxation implications empowers investors to make informed decisions, fostering financial growth and security. Whether you seek wealth creation, regular income, or long-term savings, there's a mutual fund category designed to meet your needs in the ever-evolving world of finance.

Product Team

Wise Funds