Choosing 1 Mutual Fund from 351

“But for long term prospects you should invest in equities, invest in equity mutual funds if you do not have time to track the market yourself” stresses your advisor. You nod sagely to this advice and then, inspired by the talk, decide to allocate a part of your portfolio to equities.

After the advisor has left, you roll up your sleeves, open your favorite browser and type “Equity Mutual Funds” in Google and bam! Over 100 entries; each promising more knowledge on the topic, you don’t know which link to click let alone which fund to invest. You may click on a link that gives you more knowledge on the category, but which fund to invest, that remains a mystery.

On further investigation you find that there are around 351 Equity mutual funds (excluding Other ETFs) running in India right now, (Data Source: AMFI Monthly data, November 2013) out of these 300+ funds, all of which invest in equities, all of which claim to be the best avenues in which to park your hard earned money. So where should you park your money? You could now be more confused than what you were before you started!

So let us help you solve this mystery by telling you about the types of Equity funds there are in the market and what they do. We hope that this may help you reach your investment decision.

There are six broad categories of Equity Funds -

1. Diversified Equity Funds

2. Sector Funds

3. Thematic Funds

4. Equity Linked Savings Schemes

5. Equity Income or Dividend Yield Schemes

6. Arbitrage Fundsx

Here is a small write up on each so as to give you insights into the different types of equity funds.

Before we move on to their types , there are two things you need to do:

No 1. Remember the old adage “Higher the risk, higher the return”

No. 2 Consider this example:
Take two example of stock exchanges – PQR and XYZ consider the following 10 stocks which trade on both exchanges:

Diversified Equity Funds

Diversified equity fund is a category of funds that invest in a diverse mix of securities that cut across sectors. Here the Fund Manager of a Diversified Equity Fund will spread his portfolio across all sectors. Thus his fund is likely to have the following stocks - One from automobile (lets say “A”) and one from each sector. So his portfolio will look like A,D,E,F,G,H,I,J.

Such a fund is not restricted to a particular sector or theme but is spread across stocks covering the market. Due to this spread the risk that goes with an individual sector or theme is reduced, therefore making a good avenue to invest in equities. Remember rule no. 1? Since this is the most diversified portfolio it is also comparatively low on risk from an equities perspective. However, it is pertinent to note that equities themselves carry an inherent risk.

Sector Funds

Sector funds however invest in only a specific sector. The exact opposite of a diversified equity fund. A sector fund restricts itself to one particular sector. To use our example an automobile sector fund manager is likely to have stocks A, B and C in his portfolio. Coming back to Rule no 1. Since this is the most concentrated fund the risk is the highest and if the automobile sector is doing well, the returns are likely to be subsequently higher too. However the reverse is also true, if the sector is not doing well, then the loses are likely to be that much higher. Compared to diversified equity funds sector funds generally carry the highest risk.

Thematic funds

Thematic funds invest in line with an investment theme. Going back to our example, an automobile thematic fund might invest in shares of A,C,D,E and I. Automobiles, ancillaries, steel and petrochem, all related to the automobile sector. The investment is thus more broad-based than a sector fund; but narrower than a diversified equity fund. Thus on the risk parameter thematic funds are closer to sector funds in terms of risk.

Equity Linked Savings Schemes

Popularly known by their acronym ELSS, an Equity Linked Savings Scheme offers tax benefits to investors. Investors can claim an exemption under Section 80C by investing in ELSS schemes. However, the investor is expected to retain the Units for at least 3 years, as ELSS schemes have a 3 year lock in period, during which an investor cannot redeem his funds. The portfolio of an ELSS scheme is likely to resemble that of a diversified equity fund and ranks alongside diversified equity funds in the risk parameter.

Arbitrage Funds

Arbitrage Funds take advantage of differential pricing in different markets securities, such that the risk is neutralized, but a return is earned. For instance, an arbitrage fund manager will buy stock “C” on PQR and simultaneously sell the same share in XYZ at a marginally higher price, taking advantage of the minor difference in share price between the two indices.

Most arbitrage funds take contrary positions between the equity market and the futures and options market. (‘Futures’ and ‘Options’ are commonly referred to as derivatives. These are designed to help investors to take positions or protect their risk in some other security, such as an equity share. They are traded in stock exchanges). The jury is still out on whether it makes sense for retail investors to invest in arbitrage funds, since the difference between prices on indices PQR and XYZ is minimal and looking at taxes, transaction costs and expense ratios, the opportunities for making money are minimal. Some believe that due to the ever present differential, arbitrage funds are good vehicles for investment.

Equity Income / Dividend Yield Schemes

Equity Income / Dividend Yield Schemes invest in securities whose shares fluctuate less, and therefore, dividend represents a larger proportion of the returns on those shares. The NAV of such equity schemes are expected to fluctuate lesser than other categories of equity schemes.

To continue our example, stock G is an FMCG giant that is known to declare higher dividends, as is the pharma giant H. These stocks will be a part of the portfolio of a Dividend yield scheme. On the risk parameter dividend yield schemes will carry one of the lowest risks in equities, at par with diversified equity funds.

These are the various kinds of equity funds into which you can invest. Hope this article has helped cleared some doubts in equities.

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The views expressed here in this article are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.