Mutual Fund is an instrument of investing money. Now-a-days, bank rates have fallen down and are generally below the inflation rate. Therefore, keeping large amounts of money in bank is not a wise option, as in real terms the value of money decreases over a period of time.
One of the options is to invest the money in stock market. But a common investor is not informed and competent enough to understand the intricacies of stock market. This is where mutual funds come to the rescue.
A mutual fund is a group of investors operating through a fund manager to purchase a diverse portfolio of stocks or bonds. Mutual funds are highly cost efficient and very easy to invest in. By pooling money together in a mutual fund, investors can purchase stocks or bonds with much lower trading costs than if they tried to do it on their own. Also, one doesn’t have to figure out which stocks or bonds to buy. But the biggest advantage of mutual funds is diversification.
Diversification means spreading out money across many different types of investments. When one investment is down another might be up. Diversification of investment holdings reduces the risk tremendously.
On the basis of their structure and objective, mutual funds can be classified into following major types:
GROWTH FUNDS
Growth funds are those mutual funds that aim to achieve capital appreciation by investing in growth stocks. They focus on those companies, which are experiencing significant earnings or revenue growth, rather than companies that pay out dividends.
Growth funds tend to look for the fastest-growing companies in the market. Growth managers are willing to take more risk and pay a premium for their stocks in an effort to build a portfolio of companies with above-average earnings momentum or price appreciation.
In general, growth funds are more volatile than other types of funds, rising more than other funds in bull markets and falling more in bear markets. Only aggressive investors, or those with enough time to make up for short-term market losses, should buy these funds.
LARGE CAP FUNDS
Large cap funds are those mutual funds, which seek capital appreciation by investing primarily in stocks of large blue chip companies with above-average prospects for earnings growth.
Different mutual funds have different criteria for classifying companies as large cap. Generally, companies with a market capitalisation in excess of Rs. 1000 crore are known large cap companies. Investing in large caps is a lower risk-lower return proposition (vis-à-vis mid cap stocks), because such companies are usually widely researched and information is widely available.
Mid cap funds are those mutual funds, which invest in small / medium sized companies. As there is no standard definition classifying companies as small or medium, each mutual fund has its own classification for small and medium sized companies. Generally, companies with a market capitalization of up to Rs. 500 crore are classified as small. Those companies that have a market capitalization between Rs. 500 crore and Rs. 1,000 crore are classified as medium sized.
Big investors like mutual funds and Foreign Institutional Investors are increasingly investing in mid caps nowadays because the price of large caps has increased substantially. Small / mid sized companies tend to be under researched thus they present an opportunity to invest in a company that is yet to be identified by the market. Such companies offer higher growth potential going forward and therefore an opportunity to benefit from higher than average valuations.
But mid cap funds are very volatile and tend to fall like a pack of cards in bad times. So, caution should be exercised while investing in mid cap mutual funds.
CLOSED-END MUTUAL FUNDS
A closed-end mutual fund has a set number of shares issued to the public through an initial public offering. These funds have a stipulated maturity period generally ranging from 3 to 15 years.
The fund is open for subscription only during a specified period. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where they are listed.
Once underwritten, closed-end funds trade on stock exchanges like stocks or bonds. The market price of closed-end funds is determined by supply and demand and not by net-asset value (NAV), as is the case in open-end funds. Usually closed mutual funds trade at discounts to their underlying asset value.
OPEN END MUTUAL FUND
An open-end mutual fund is a fund that does not have a set number of shares. It continues to sell shares to investors and will buy back shares when investors wish to sell. Units are bought and sold at their current net asset value.
Open-end funds keep some portion of their assets in short-term and money market securities to provide available funds for redemptions. A large portion of most open mutual funds is invested in highly liquid securities, which enables the fund to raise money by selling securities at prices very close to those used for valuations.
BALANCED FUND
Balanced fund is also known as hybrid fund. It is a type of mutual fund that buys a combination of common stock, preferred stock, bonds, and short-term bonds, to provide both income and capital appreciation while avoiding excessive risk.
Balanced funds provide investor with an option of single mutual fund that combines both growth and income objectives, by investing in both stocks (for growth) and bonds (for income). Such diversified holdings ensure that these funds will manage downturns in the stock market without too much of a loss. But on the flip side, balanced funds will usually increase less than an all-stock fund during a bull market.
MONEY MARKET FUNDS
A money market fund is a mutual fund that invests solely in money market instruments. Money market instruments are forms of debt that mature in less than one year and are very liquid. Treasury bills make up the bulk of the money market instruments. Securities in the money market are relatively risk-free.
Money market funds are generally the safest and most secure of mutual fund investments. The goal of a money-market fund is to preserve principal while yielding a modest return. Money-market mutual fund is akin to a high-yield bank account but is not entirely risk free. When investing in a money-market fund, attention should be paid to the interest rate that is being offered.
INTERNATIONAL MUTUAL FUNDS
International mutual funds are those funds that invest in non-domestic securities markets throughout the world. Investing in international markets provides greater portfolio diversification and let you capitalize on some of the world’s best opportunities. If investments are chosen carefully, international mutual fund may be profitable when some markets are rising and others are declining.
However, fund managers need to keep close watch on foreign currencies and world markets as profitable investments in a rising market can lose money if the foreign currency rises against the dollar.
VALUE FUNDS
Value funds are those mutual funds that tend to focus on safety rather than growth, and often choose investments providing dividends as well as capital appreciation. They invest in companies that the market has overlooked, and stocks that have fallen out of favour with mainstream investors, either due to changing investor preferences, a poor quarterly earnings report, or hard times in a particular industry.
Value stocks are often mature companies that have stopped growing and that use their earnings to pay dividends. Thus value funds produce current income (from the dividends) as well as long-term growth (from capital appreciation once the stocks become popular again). They tend to have more conservative and less volatile returns than growth funds.
Consult some financial expert before investing in Mutual Funds
EXCHANGE TRADED FUNDS
Exchange Traded Funds (ETFs) represent a basket of securities that are traded on an exchange. An exchange traded fund is similar to an index fund.
It will primarily invest in the securities of companies that are included in a selected market index. An ETF will invest in either all of the securities or a representative sample of the securities included in the index. The investment objective of an ETF is to achieve the same return as a particular market index.
Exchange traded funds rely on an arbitrage mechanism to keep the prices at which they trade roughly in line with the net asset values of their underlying portfolios.
FUND OF FUNDS
A fund of funds is a type of mutual fund that invests in other mutual funds. Just as a mutual fund invests in a number of different securities, a fund of funds holds shares of many different mutual funds.
Fund of funds are designed to achieve greater diversification than traditional mutual funds. But on the flipside, expense fees on fund of funds are typically higher than those on regular funds because they include part of the expense fees charged by the underlying funds. Also, since a fund of funds buys many different funds which themselves invest in many different stocks, it is possible for the fund of funds to own the same stock through several different funds and it can be difficult to keep track of the overall holdings.
SECTOR MUTUAL FUNDS
Sector mutual funds are those mutual funds that restrict their investments to a particular segment or sector of the economy. These funds concentrate on one industry such as infrastructure, health care, utilities, pharmaceuticals etc. The idea is to allow investors to place bets on specific industries or sectors, which have strong growth potential.
These funds tend to be more volatile than funds holding a diversified portfolio of securities in many industries. Such concentrated portfolios can produce tremendous gains or losses, depending on whether the chosen sector is in or out of favour.
NO-LOAD MUTUAL FUNDS
Mutual funds can be classified into two types—Load mutual funds and No-Load mutual funds. Load funds are those funds that charge commission at the time of purchase or redemption. They can be further subdivided into—1. Front-end load funds and 2. Back-end load funds. Front-end load funds charge commission at the time of purchase and back-end load funds charge commission at the time of redemption.
On the other hand, no-load funds are those funds that can be purchased without commission. No-load funds have several advantages over load funds. Firstly, funds with loads, on average, consistently under-perform no-load funds when the load is taken into consideration in performance calculations. Secondly, loads understate the real commission charged because they reduce the total amount being invested. Finally, when a load fund is held over a long time period, the effect of the load, if paid up front, is not diminished because if the money paid for the load had invested, as in a no-load fund, it would have been compounding over the whole time period.
