Types of Equity Mutual Funds

We all know what a mutual fund is. A Mutual fund is nothing but a common pool of money collected from investors and managed by a fund manager who would buy/sell stocks on our behalf and share the profit/loss with us. To know more about mutual funds click here

If somebody is talking about mutual funds, almost always they talk about equity mutual funds.

What is an Equity Mutual Fund?

A MF scheme that invests at least 65% of its fund corpus into equity and equity related instruments is called an equity mutual fund. Equity funds carry the most risk among all kinds of MFs because they invest in the stock market. This risk comes with the potential of high returns.

Types of Equity mutual funds:

Based on the investing style equity mutual funds are broadly classified into 4 categories:

1. Equity Diversified funds
2. Equity Linked Saving Schemes (ELSS)
3. Index funds & ETFs
4. Sectoral Funds

Equity Diversified Funds:

These are actively managed funds that invest across stocks and sectors. They do not concentrate on only a few sectors or scrips but focus on either large-caps or mid and small caps. They could also be thematic, for instance funds focusing on rural growth or infrastructure. These funds are riskier than index funds because their performance depends on the fund managers abilities to buy and sell the right stocks at the right time.

The top 3 Equity diversified funds are:

1. ICICI Prudential Infrastructure fund
2. Reliance RSF – Equity
3. UTI dividend yield fund

ELSS funds:

ELSS are also diversified equity funds but offer income tax deduction under sec 80C up to a limit of Rs. 1 lakh. It also imposes a three year lock in period. You cannot redeem your units before the end of 3 years.

The top 3 ELSS funds are:

1. Sundaram BNP Paribas tax saver
2. SBI Magnum Tax gain
3. Fidelity Tax Advantage

Index Funds:

These are the simplest and least risky of all equity funds. They invest in all the scrips and in exactly the same proportion as the scrips lie in their underlying benchmark indices. While an index fund buys and sells scrips on the stock exchanges, an ETF (Exchange Traded Fund) appoints market participants. They exchange a basket of securities (whose composition exactly matches that of the benchmark index) against an ETF unit. These ETF units are then traded on stock exchanges like stocks.

While index funds can be bought or sold from the MF or through an agent like any other ordinary scheme, ETFs can only be bought and sold on exchanges, therefore you need a DEMAT account to buy/sell them.

Sectoral Funds:

These are the riskiest of all funds. They invest in a single or at best two or three closely linked sectors. Their fortunes depend on these select sectors & its stocks only. As their name indicates, the fund house buys/sells stocks only in the sector on which it declared to invest while offering the fund. If the sector that the fund house invests performs well then our returns would be more than a equity diversified fund or an index fund but at the same time, if a sector underperforms our returns would get affected adversely. These funds are not for the normal investor. It is only for high risk and knowledgeable investors who can actively track their portfolio and exit a sector before it is adversely affected.

Note: This is not a recommendation to buy the mutual funds mentioned in their respective categories. This is just an illustration to point out the best funds in the categories as per my view as of today April 5th 2009. The funds performance may change its ranking over the next few weeks/months/years.