Last week, we discussed the types of mutual funds and their efficiency. This week, let us look at each set of funds in detail.
LARGE CAP FUNDS:
These funds invest 80% of the assets in top 100 stocks of the stock market by market cap. Since these are large companies, they are usually more stable with leadership status in their respective sectors. Hence, even if they fall, they would be the first to bounce back. Many investors find solace by investing in this category of funds.
MID CAP FUNDS:
101st to 250th stock by market cap is classified as Midcap Stocks. These funds invest at least 65% of the assets in these stocks.
SMALL CAP FUNDS:
Any stock beyond 250th stock is classified as Small Cap stocks. These funds invest 65% of their assets in this category of stocks. Since these stocks are relatively smaller in size, they are more volatile when compared to large and midcap stocks. But every large cap stock would have once been a small cap company or a mid cap company. Identifying them early and investing in them could be rewarding as these companies grow and mature.
LARGE & MID CAP FUNDS:
These funds invest at least 35% of their assets in large cap and 35% in mid cap stocks. Since they get a wider investment universe, these funds are much better than a plain large cap or mid cap fund.
MULTI CAP FUNDS:
SEBI has recently tweaked the definition of a multi cap fund. These funds are now mandated to invest 25% of the money in each of these categories of stocks – large, mid and small. And the balance can be invested as per the discretion of the fund manager. The earlier definition was to invest 65% of the assets in equities – without any limitations on the market cap. Instead of investing separately in large, mid and small cap funds, investing in multicap funds could be a convenient solution.
It is natural that investors get lured by the high returns of equity mutual funds. But they need to keep in mind the associated risks before investing.
Equity mutual funds in general invest in 50 to 100 stocks. Though diversification is key to reducing risk, at times over-diversification proves counter-productive and reduces the returns too. Hence the need for a focused fund that invests in 20 to 30 stocks. But investors need to understand the relatively higher risk when compared to well-diversified fund.
DIVIDEND YIELD FUNDS:
Dividends don’t lie. If a company is making cash profits, it will be in a position to pay dividends and vice versa. Hence dividend payment is one of the traits of a good company. A mutual fund that invests 65% of its assets in such dividend-paying stocks – across market caps – is called the Dividend Yield Fund. For that reason, it does not mean that these funds will in turn declare regular dividends.
These funds invest in a theme – like infrastructure, healthcare, lifestyle, rural India, etc. All these funds would have been launched whenever there were favourable market conditions. While the theme may look attractive, we need to understand the relevance of the theme before investing.
These funds invest 80% of their assets in specific sectors like pharma, IT, banking, FMCG, etc. While the risk profile of a sectoral fund is the highest among equity funds, they are relevant for those investors who are confident of the growth prospect of a sector but are not sure of which stocks to invest. Investing in a sectoral fund is like bucket investing – you invest in all stocks of the sector.
This is a category of mutual funds that mirrors the index composition. These funds are also referred to as passive funds since there is no need for active stock selection or research. These portfolios mimic the underlying index like Nifty 50 or Sensex or Nifty 500 etc. Hence the returns they generate are almost similar to the index returns.
The total value of the Indian stock market is hardly 3% of the global market. Hence investing all your money in the Indian stock market means that you are missing 97% of the opportunity. Luckily, we have various international funds like US Bluechip Funds, Nasdaq Funds, European Funds, etc., which invest in the best of these markets. Through these funds, we can participate and capture the growth of economies beyond India.
To sum up
It is natural that investors get lured by the high returns of equity mutual funds. But they need to keep in mind the associated risks before investing. While Mutual funds are managed by professional fund managers, believing that they can avoid all losses and generate huge returns is a myth.
Since the underlying asset is equity, whenever the broader market fluctuates, the investment value would also fluctuate. All that these fund managers could do is: realign the portfolio and capture the growth in the best possible way. In India, we have 40 plus mutual funds, which means we have 40 different teams of investment managers. We need to choose those mutual funds which align with our interest to grow our money.