That said, mutual funds offer a lot of benefits that trading on stocks do not. But along with these mutual funds benefits come the risks as well. Read on to know more about the various kinds of top mutual funds in the market today.
Mutual Funds -Varying Typologies
Based on the nature of investments, each Mutual Fund can declare the type of instrument it will invest in. This divides further into equity fund schemes, diversified funds, gilt funds, money market funds, sector specific, debt fund schemes, and index funds.
While debt funds or schemes are also called income funds, diversified funds or schemes are called balanced funds. Based on the time of closure of the scheme, the mutual funds basics can also be categorized into open ended and close ended schemes. Where there is no specific date as to when the scheme will be closed, it is open ended. So, while open ended funds are more liberal in their outlook, close ended funds are fairly narrow-minded!
Based on tax incentive schemes, mutual funds can be divided into tax saving and not tax saving funds. Another typology is possible based on periodicity/time of pay outs such as dividends. The categorization is as follows:
- Dividend Paying Fund Schemes
- Reinvestment Schemes
What is important is that mutual funds work for the mutual benefits of investors and companies. Schemes can also be in various permutations and combinations. For example, equity funding is open ended and can have a dividend paying plan.
Look before your leap is a fit adage for the mutual fund markets. Prior to investment, one should be clear about the nature of the scheme and chose as per risk aversion and periodicity of dividends from the scheme.
Mutual Funds: Various Types
Index funds are those mutual funds which invest in a portfolio of securities representing the entire particular market or its piece. An example would be the entire stock market or just part of it such as international stocks or small firms. Funds can be built to duplicate the performance of their relevant market. Index funds track the market’s indexes. These funds are affordably priced and easy to maintain. For instance, an NSE index fund will aim to provide the same return as the NSE index.
Actively managed funds are those which are actively managed by professionals or portfolio managers who pick stocks that match investment strategies. With respect to the market index, the aim of such funds is to outperform it. For example, rather than tracking the NSE index,active stock managers in India will try to outdo the index. Investors have to pay managers for their work and it is up to the mutual funds managers to outsmart the index.
Lifecycle or target date funds are those which invest in a blend of stocks and bonds. These are basically mutual funds which are made of investments in other funds. The allocation of the fund to its investments changes over a period of time. With age, not only does the investor turn older but also the ratio of money allocated to stocks versus bonds becomes conservative. This really works well if you have a portfolio manager to monitor the funds.
Lifestyle funds are those which involve a blend of stock and bond funds which do not change over time. Lifestyle funds can be moderate, aggressive or conservative.
Tax managed funds are mutual funds that aim to keep taxable capital gains, plus other distributions to fund holders to smallest percentage.
Balanced funds are those which invest in a combination of stocks and bonds. These funds have a conservative mix of close to 60% in stocks and the remaining pre cutting in bonds typically. Balanced funds are a combination of growth and income funds. They provide current income and more growth later. Such mutual funds have low to moderate stability. Further striking an even keel, they promise moderate mutual funds returns though the investor does experience some risk.
Income funds are those mutual funds which invest in fixed income securities thereby generating a regular income. Though this is a stable option, it is not without its risks. Income funds interest rates are sensitive to a certain degree.
Open or Close: The Many Options
A close ended fund has fixed shares which are outstanding and operate for a fixed duration of around a decade. Such funds are open for a limited time only and are traded on the stock exchange with a specified redemption period. Open ended funds are there for subscription throughout the year. Unlike close ended funds, these are not listed on the stock exchange. These are open end funds because investors have the flexibility to purchase or sell their investment at any point in time.
Opening a World of Possibilities: Different Open Ended Funds
Debt/income schemes are those where a massive part of the investable fund is channelized via debentures, government securities and debt instruments. Capital appreciation is low as against equity mutual funds. There is a low risk associated with this type of mutual fund but there are low returns as well.
Money market mutual fund schemes are aimed at capital preservation whereby gains will follow through as interest rates are higher on these types of funds as against bank deposits. These funds pose less risk and are highly liquid. These funds are ideal for investors who want short term instruments while waiting for better options. Reasonable returns are the USP of these funds.
Equity or growth funds are a popular mutual fund among those who are retail investors. This could be a high risk investment for the short term, but more than make up for it in the long term. For long term benefits, this is the best open ended fund.
Index schemes follow passive investment strategies and benchmark indices such as Sensex and Nifty. Another type of open ended funds are sectoral funds invested in specific sectors such as IT, pharmaceuticals or segments of the capital market such as small, medium and large caps. The risks are high, but so are the returns.
Another type of open ended schemes are tax saving which offer long term opportunities and tax benefits. Called Equity Linked Savings schemes, they have a 3 year lock in period.
Balanced funds are a type of open ended funds to enjoy growth and income at regular intervals and is perfect for investors who are cautious yet risk taking.
Closing the Investment Gap Safely: Close Ended Mutual Fund Schemes
Close ended mutual funds are those which have a stipulated maturity period and investors can invest during the New Fund Offer period for a limited time only. These are protective mutual funds which invest and guard capital at the same time. A close ended mutual fund is capital protection. In this type of fund, the principal amount is safeguarded while reasonable returns are delivered. Investing in high quality fixed income securities with limited exposure to equities is another feature of this mutual fund.
Fixed Maturity Plans or FMPs are mutual fund schemes within a maturity period which is specific. Schemes include debt instruments which mature in line with a particular time period and earn interest component of securities within a portfolio. The interest component is referred as as coupons. Fixed maturity plans are passively managed and expenses incurred for this scheme are lower than actively managed schemes.
Interval Mutual Funds: Best of Both Worlds
Operating within the combination of open and close ended schemes, they give investors the chance to trade units at intervals which are predetermined.
Managing the Mutual Fund: Active Versus Passive Distinction
Actively managed funds means there are active attempts by the portfolio manager to outperform the market or trade benchmarks. Passive management includes holdings where the securities are designed to measure and replicate the mutual funds performance of benchmark indexes.
One of a Kind: Specialty Funds
These funds are associated with certain mandates such as social causes, commodities, real estate and so on. An example of this kind of mutual fund is social or ethical investing where the fund invests in mutual funds companies that promote environmental stewardship, human rights as well as inclusion while avoiding defense, military, gambling or alcoholic beverages industries.
Funds of Funds: The Bigger Picture
These funds invest in other funds and are similar to balanced funds. They have higher MER as against stand alone mutual funds.
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The Philosophy of Investing: Many Approaches
Portfolio managers follow different investment philosophies and styles of investing to meet a fund’s investment objectives. Funds with different investment styles permit diversification beyond type of investment and a good means of reducing risk.
- Top-Down Approach: This approach towards investing looks at the larger economic picture and invests in specific companies which look set to perform well in the long term.
- Bottom-Up Approach: This focuses on choosing specific companies that perform well regardless of the state of the industry and/or economy.
- A blend of the two is generally followed by portfolio managers overseeing a global portfolio.
- Technical analysis is yet another style of investing which relies on past market data to detect the direction of investment prices.
Around the World: Mutual Funds by Region
Global or international funds are those where the investor makes an investment anywhere in the world. The upside of these funds is that they are part of a well balanced portfolio which reduces risk through diversification while carrying country and political risks.
Sector funds are targeted at specific sectors of the economy including health, finance and biotechnology. This is a mutual fund scheme which is extremely risky and consequently immensely profitable.
Regional funds focus on certain parts of the world like a particular region or nation. These mutual fund stocks make it easier to invest in foreign countries, but you have to be ready for a high percentage of losses. This is because local factors tend to be very influential in deciding the fate of such mutual funds. From political leadership to economic status, the region’s dynamics affect the mutual fund and the money made from it.
Conclusion
Rob Chernow said that the best part about mutual funds is that they offer safety and diversification, but they do not necessarily offer diversification or safety.
A lot of analysts have talked about how mutual funds are subject to risks and the offer document is an important consideration. Mutual funds have a risk-reward trade-off whereby the higher the risk, the greater the reward.
The only trick is minimizing the risk and maximizing the gains. But the catch is that reward is only possible where there is risk. Mutual funds are a form of investment that is just as risky as futures trading…the only difference is that you are entrusting the capital to a portfolio manager who is a skilled professional adept at getting the rewards without incurring the risks. Choosing the right mutual fund and how to invest in mutual funds can have immediate and long term financial repercussions. Cash is a fact, but profit is an opinion. Mutual funds make that opinion a certainty.
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