Home Wealth Products Mutual Funds What are the different kinds of Equity Funds?

What are the different kinds of Equity Funds?

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Equity funds invest in a portfolio of equity shares and equity-related instruments. Since the portfolio comprises of the equity instruments, the risk and return from the scheme will be similar to directly investing in equity markets. Equity funds can be further categorized on the basis of the strategy adopted by the fund managers to manage the fund.

Passive funds invest the money in the companies represented in an index such as Nifty or Sensex in the same proportion as the company’s representation in the index. There is no selection of securities or investment decisions taken by the fund manager as to when to invest or how much to invest in each security.

Active funds select stocks for the portfolio based on a strategy that is intended to generate a higher return than the index. Active funds can be further categorized based on the way the securities for the portfolio are selected.

Diversified equity funds invest across segments, sectors and sizes of companies. Since the portfolio takes exposure to different stocks across sectors and market segments, there is a lower risk in such funds of the poor performance of a few stocks or sectors.

Based on the segment of the market – Equity funds may focus on a particular size of companies to benefit from the features of such companies. Equity stocks may be segmented based on market capitalization as large-cap, mid-cap and small-cap stocks.

Large-cap funds invest in stocks of large, liquid blue-chip companies with stable performance and returns.

Mid-cap funds invest in mid-cap companies that have the potential for faster growth and higher returns. These companies are more susceptible to economic downturns and evaluating and selecting the right companies becomes important. Funds that invest in such companies have a higher risk of the companies selected not being able to withstand the slowdown in revenues and profits. Similarly, the price of the stocks also falls more when markets fall.

Small-cap funds invest in companies with small market capitalisation with the intent of benefitting from the higher gains in the price of stocks. The risks are also higher.

Sector funds invest in companies that belong to a particular sector such as technology or banking. The risk is higher because of lesser diversification since such funds are concentrated in a particular sector. Sector performances tend to be cyclical and the return from investing in a sector is never the same across time. For example, Auto sector, does well, when the economy is doing well and more cars, trucks and bikes are bought. It does not do well when demand goes down. Banking sector does well when interest rates are low in the market; they don’t do well when rates are high. Investments in sector funds have to be timed well. Investment in sector funds should be made when the fund manager expects the related sectors, to do well. They could out-perform the market if the call on sector performance plays out. In case it doesn’t, such funds could underperform the broad market. Reliance Banking Fund, SBI Magnum Sector Funds are examples of sector funds.

Based on Themes – Theme-based funds invest in multiple sectors and stocks that form part of a theme. For example, if the theme is infrastructure then companies in the infrastructure sector, construction, cement, banking and logistics will all form part of the theme and be eligible for inclusion in the portfolio. They are more diversified than sector funds but still have high concentration risks.

Based on Investment Style The strategy adopted by the fund manager to create and manage the fund’s portfolio is a basis for categorizing funds. The investment style and strategy adopted can significantly impact the nature of risk and return in the portfolio. Passive fund invests only in the securities included in an index and does not feature selection risks. However, the returns from the fund will also be only in line with the market index. On the other hand, active funds use selection and timing strategies to create portfolios that are expected to generate returns better than the market returns. The risk is higher too since the fund’s performance will be affected negatively if the selected stocks do not perform as expected. The type of funds based on strategies and styles for selection of securities include

Growth Funds portfolios feature companies whose earnings are expected to grow at a rate higher than the average rate. These funds aim at providing capital appreciation to the investors and provide above-average returns in bullish markets. The volatility in returns is higher in such funds.

Value Funds seek to identify companies that are trading at prices below their inherent value with the expectation of benefiting from an increase in price as the market recognizes the true value. Such funds have lower risk. They require a longer investment horizon for the strategy to play out.

Dividend yield Funds invest in stocks that have a high dividend yield. These stocks pay a large portion of their profits as dividend and these appeals to investors looking for income from their equity investments. The companies typically have a high level of stable earnings but do not have much potential for growth or expansion. therefore pay high dividends while the stock prices remain stable. The stocks are bought for their dividend payout rather than for the potential for capital appreciation.

Equity Linked Savings Schemes (ELSS) is a special type of equity fund investment which gives the investor tax deduction benefits under section 80C of the Income Tax Act up to a limit of Rs. 1,50,000 per year. An ELSS must hold at least 80% of the portfolio in equity securities. The investment made by the investor is locked-in for a period of three years during which it cannot be redeemed, transferred or pledged.

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