Mutual fund products can be classified based on their underlying portfolio compositions as below:

  • The first level of categorization will be on the basis of the asset class the fund invests in, such as equity/debt/money market instruments or gold.
  • The second level of categorization is on the basis of strategies and styles used to create the portfolio, such as Income fund, Dynamic Bond Fund, Infrastructure fund, Large-cap/Mid-cap/Small-cap Equity fund, Value fund, etc.
  • The portfolio composition flows out of the investment objectives of the scheme.
  1. Equity Funds:

    Equity funds invest in equity instruments issued by companies. The funds target long-term appreciation in the value of the portfolio from the gains in the value of the securities held and the dividends earned on it. The securities in the portfolio are typically listed on the stock exchange, and the changes in the price of the securities are reflected in the volatile returns from the portfolio. These funds can be categorized based on the type of equity shares that are included in the portfolio and the strategy or style adopted by the fund manager to pick the securities and manage the portfolio.

    1. Diversified Equity Fund:

      Diversified Equity Fund is a category of funds that invest in a diverse mix of securities that cut across sectors and market capitalization. The risk of the fund’s performance is significantly affected by the poor performance of one sector or segment is low.

    2. Market Segment Funds:

      Market Segment Funds invest in companies of a particular market size. Equity stocks may be segmented based on market capitalization as large-cap, mid-cap, and small-cap stocks as below

        • Large-Cap Funds: Invest in stocks of large, liquid blue-chip companies with stable performance and returns.
          # (Large Cap: 1st -100th company in terms of full market capitalization)
        • 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. Therefore, evaluating and selecting the right companies becomes important. Funds that invest in such companies have a higher risk, since the selected companies may not be able to withstand the slowdown in revenues and profits. Similarly, the price of the stocks also falls more when markets fall.
          # (Mid Cap: 101st -250th company in terms of full market capitalization)
        • Small-Cap Funds: Invest in companies with small market capitalization with the intent of benefitting from the higher gains in the price of stocks. The risks are also higher.
          # (Small Cap: 251st company onwards in terms of full market capitalization)
    3. Sector Funds:

      Sector Funds invest in only a specific sector. For example, a banking sector fund will invest in only shares of banking companies. Gold sector fund will invest in only shares of gold-related companies. The performance of such funds can see periods of under-performance and out-performance as it is linked to the performance of the sector, which tends to be cyclical. Entry and exit into these funds need to be timed well so that the investor does not invest when the sector has peaked and exit when the sector performance falls. This makes the scheme riskier than a diversified equity scheme.

    4. Thematic Funds:

      Thematic Funds invest in line with an investment theme. For example, an infrastructure thematic fund might invest in shares of companies that are into infrastructure construction, infrastructure toll-collection, cement, steel, telecom, power, etc. The investment is thus more broad-based than a sector fund, but narrower than a diversified equity fund and still has the risk of concentration.

    5. Strategy-Based Schemes:

      Strategy-based schemes have portfolios that are created and managed according to a stated style or strategy.

      1. Equity Income/Dividend Yield Schemes:
        Equity Income or dividend yield schemes invest in securities whose shares fluctuate less, and the dividend represents a larger proportion of the returns on those shares. They represent companies with stable earnings but not many opportunities for growth or expansion. The NAV of such equity schemes are expected to fluctuate lesser than other categories of equity schemes.
      2. Value Fund:
        Value Fund invests in shares of fundamentally strong companies that are currently undervalued in the market with the expectation of benefiting from an increase in price as the market recognizes the true value. Such funds have a lower risk. They require a longer investment horizon for the strategy to play out.
      3. Growth Funds:
        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.
      4. Focused Funds:
        Focused funds hold portfolios concentrated in a limited number of stocks. Selection risks are high in such funds. If the fund manager selects the right stocks then the strategy pays off. If even a few of the stocks do not perform as expected the impact on the scheme’s returns can be significant as they constitute a large part of the portfolio.
      5. Equity Linked Savings Schemes (ELSS):
        Equity Linked Savings Schemes are diversified equity funds that offer tax benefits to investors under section 80 C of the Income Tax Act up to an investment limit of Rs.150,000 a year. ELSS is required to hold at least 80 percent of its portfolio in equity instruments. The investment is subject to lock-in for a period of 3 years during which it cannot be redeemed, transferred or pledged. However, this is subject to change in case there are any amendments in the ELSS Guidelines with respect to the lock-in period.
  2. Debt Funds:

    Debt funds are categorized on the basis of the type of debt securities they invest in. The distinction can be primarily on the basis of the tenor of the securities—short term or long term, and the issuer: government, corporate, PSUs and others. The risk and return of the securities will vary based on the tenor and issuer. The strategy adopted by the fund manager to create and manage the portfolio can also be a factor for categorizing debt funds.

    1. On the basis of Issuer:

      1. Gilt Funds: Gilt Funds invest in only treasury bills and government securities, which do not have a credit risk (i.e. the risk that the issuer of the security defaults). These securities pay a lower coupon or interest to reflect the low risk of default associated with them. Long-term gilt funds invest in government securities of medium and long-term maturities. There is no risk of default and liquidity is considerably higher in the case of government securities. However, the prices of long-term government securities are very sensitive to interest rate changes.
      2. Corporate Bond Funds: Corporate Bond Funds invest in debt securities issued by companies, including PSUs. There is a credit risk associated with the issuer that is denoted by the credit rating assigned to the security. Such bonds pay a higher coupon income to compensate for the credit risk associated with them. The price of corporate bonds is also sensitive to interest rate changes depending upon the tenor of the securities held.
    2. On the basis of Tenor:

      1. Liquid Schemes: Liquid Schemes are a variant of debt schemes that invest only in short-term debt securities. They can invest in debt securities of up to 91 days of maturity. However, securities in the portfolio having a maturity of more than 60 days need to be valued at market prices [“marked to market” (MTM)]. Since MTM contributes to the volatility of NAV, fund managers of liquid schemes prefer to keep most of their portfolio in debt securities of less than 60-day maturity. This helps in positioning liquid schemes as the lowest in price risk among all kinds of mutual fund schemes. Therefore, these schemes are ideal for investors seeking high liquidity with safety of capital.
      2. Short Term Debt Schemes: Short Term Debt Schemes invest in securities with short tenors that have low interest rate risk of significant changes in the value of the securities. Ultra-short term debt funds, short-term debt funds, short-term gilt funds are some of the funds in this category. The contribution of interest income and the gain/loss in the value of the securities and the volatility in the returns from the fund will vary depending upon the tenor of the securities included in the portfolio.
      3. Ultra Short-Term Plans: Ultra Short-Term Plans are also known as treasury management funds, or cash management funds. They invest in the money market and other short-term securities. The objective is to generate a steady return, mostly coming from the accrual of interest income, with minimal NAV volatility.
      4. Short-Term Plans: Short Term Plans combine short term debt securities with a small allocation to longer term debt securities. Short term plans earn interest from short term securities and interest and capital gains from long term securities. Fund managers take a call on the exposure to long term securities based on their view for interest rate movements. If interest rates are expected to go down, these funds increase their exposure to long term securities to benefit from the resultant increase in prices. The volatility in returns will depend upon the extent of long-term debt securities in the portfolio.
      5. Long-Term Debt Schemes: Long-Term Debt Schemes such as Gilt funds and Income funds invest in longer-term securities issued by the government and other corporate issuers. The returns from these schemes are significantly impacted by changes in the value of the securities and therefore see greater volatility in the returns.
    3. On the basis of Investment Strategy:

      1. Diversified Debt Funds or Income Fund: Diversified Debt Funds or Income Funds invest in a mix of government and non-government debt securities such as corporate bonds, debentures, and commercial paper. Corporate bonds earn higher coupon income on account of the credit risks associated with them. The government securities are held to meet liquidity needs and to exploit opportunities for capital gains arising from interest rate movements.
      2. Junk Bond Schemes or High Yield Bond Schemes: Junk Bond Schemes or High Yield Bond Schemes invest in securities that have a lower credit rating indicating poor credit quality. Such schemes operate on the premise that the attractive returns offered by the investee companies make up for the losses arising out of a few companies defaulting.
      3. Dynamic Debt Funds: Dynamic Debt Funds are flexible in terms of the type of debt securities held and their tenors. They do not focus on long or short-term securities or any particular category of the issuer but look for opportunities to earn income and capital gains across segments of the debt market. The duration of these portfolios are not fixed but are dynamically managed. If the manager believes that interest rates could move up, the duration of the portfolio is reduced, and vice versa.
      4. Fixed Maturity Plans: Fixed Maturity Plans are a kind of debt fund where the duration of the investment portfolio is closely aligned to the maturity of the scheme. AMCs tend to structure the scheme around pre-identified investments. Further, being close-ended schemes, they do not accept money post-NFO, therefore, the fund manager has a little ongoing role in deciding on the investment options. Such a portfolio construction gives more clarity to investors on the likely returns if they stay invested in the scheme until its maturity (though there can be no guarantee or assurance of such returns). This helps them compare the returns with alternative investments like bank deposits.
      5. Floating Rate Funds: Floating Rate Funds invest largely in floating rate debt securities i.e. debt securities where the interest rate payable by the issuer changes in line with the market. For example, a debt security where interest payable is described as ‘5-year Government Security yield plus 1 percent’, will pay interest rate of 7 percent, when the 5-year Government Security yield is 6 percent; if 5-year Government Security yield goes down to 3 percent, then only 4 percent interest will be payable on that debt security. The NAVs of such schemes fluctuate lesser than other debt funds that invest more in debt securities offering a fixed rate of interest.
  3. Hybrid Funds:

    A hybrid fund invests in a variety of asset classes, such as stocks, bonds, and gold. The allocation of these assets can vary depending on the fund’s desired outcome. The risk and return of the fund are determined by the mix of assets and the selections within each asset class that are included. If the portfolio is weighted more heavily towards equity, the risk increases. Similarly, if it includes more long-term debt or lower-rated securities, the risk of the fund rises.

    1. Debt-Oriented Hybrid Funds: Hybrid funds that focus on debt primarily invest the majority of their assets in debt instruments with a minor part of the portfolio allocated to equity. This equity portion can be anything from 5 percent to 30 percent, as specified in the prospectus. The debt component is managed carefully to generate interest payments, while the equity component serves to enhance the overall returns.
    2. Monthly Income Plan: A Monthly Income Plan is a kind of blended fund that is debt-oriented and attempts to pay out a dividend each month. It is not ensured that dividends will be distributed each month, so the label of “Monthly Income” is a bit misleading. Therefore, it is essential for an investor to examine the scheme carefully before presuming that they will receive income every month.
    3. Multiple Yield Funds: Multiple Yield Funds generate returns over the medium term with exposure to multiple asset classes, such as equity and debt.
    4. Equity-Oriented Hybrid Funds: Equity-Oriented Hybrid Funds invest primarily in equity, with a portion of the portfolio invested in debt to bring stability to the returns. A very popular category among the equity-oriented hybrid funds is the Balanced Fund. These schemes provide investors with simultaneous exposure to both equity and debt in one portfolio. The objective of these schemes is to provide growth and stability (or regular income), where investments in equity instruments are made to meet the objective of growth while debt investments are made to achieve the objective of stability. Balanced funds can have fixed or flexible allocations between equity and debt. One can get information about the allocation and investment style from the Scheme Information Document.
    5. Capital Protected Schemes: Capital Protected Schemes are close-ended schemes, which are structured to ensure that investors get their principal back, irrespective of what happens to the market. This is ideally done by investing in Zero Coupon Government Securities whose maturity is aligned with the scheme’s maturity. (Zero coupon securities are securities that do not pay regular interest, but accumulate the interest, and pay it along with the principal when the security matures).
      Some of these schemes are structured with a minor difference – the investment is made in good-quality debt securities issued by companies, rather than Central Government Securities. Since any borrower other than the government can default, it would be appropriate to view these alternate structures as Capital Protection Oriented Schemes rather than Capital Protected Schemes.
      It may be noted that capital protection can also be offered through a guarantee from a guarantor, who has the financial strength to offer the guarantee. Such schemes are however not prevalent in the market.
      Some of the hybrid funds are also launched as Asset Allocation Funds. These funds do not specify a minimum or maximum limit for each of the asset classes. The fund manager allocates resources based on the expected performance of each asset class.
    6. Arbitrage Funds: Arbitrage Funds take opposite positions in different markets/securities, such that the risk is neutralized, but a return is earned. For instance, by buying a share in BSE, and simultaneously selling the same share in the NSE at a higher price. 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 exchanges like the NSE and the BSE. Although these schemes invest in equity markets, the expected returns are in line with liquid funds.