Mutual Fund is a vehicle that enables a collective group of individuals to:

a) Pool their investible surplus funds and invest in instruments / assets for a common investment objective.

b) Optimize the knowledge and experience of a fund manager, a capacity that they may not have individually

c) Benefit from the economies of scale, which enables size, and is not available on an individual basis

Investing in a mutual fund is like an investment made by a collective group. An individual as a single investor is likely to have lesser amount of money at disposal than, say, a group of friends put together. Now, let's assume that this group of individuals is a novice in investing and so the group turns over the pooled funds to an expert to make their money work for them. This is what a professional Asset Management Company does for mutual funds. The AMC invests the investors' money on their behalf into various assets towards a common investment objective.

Hence, technically speaking, a mutual fund is an investment vehicle which pools investors' money and invests the same for and on behalf of investors into stocks, bonds, money market instruments and other assets. The money is received by the AMC with a promise that it will be invested in a particular manner by professional managers (commonly known as fund managers). The fund managers are expected to honour this promise. The SEBI and the Board of Trustees ensure that this actually happens.

Typical classification of mutual fund schemes on various bases:

Tenure refers to the 'time'. Mutual funds can be classified on the basis of time as under:

1. Open Ended Funds

These funds are available for subscription throughout the year. These funds do not have a fixed maturity. Investors have the flexibility to buy or sell any part of their investment at any time, at the prevailing price (Net Asset Value - NAV) at that time.

2. Close Ended Funds

These funds begin with a fixed corpus and operate for a fixed duration. These funds are open for subscription only during a specified period. When the period terminates, investors can redeem their units at the prevailing NAV.

Asset classes

1. Equity Funds

These funds invest in shares. These funds may invest money in growth stocks, momentum stocks, value stocks or income stocks depending on the investment objective of the fund.

2. Debt Funds

These funds invest money in bonds and money market instruments. These funds may invest into long-term and/or short-term maturity bonds.

3. Hybrid Funds

Funds which generate regular or monthly income. These funds invest 75/25 in Debt and Equity Funds.

4. Income Funds

Funds which generate regular or monthly income. These funds invest 90/10 in Debt and Equity Funds.

5. Balance Funds

TFunds which generate regular or monthly income. These funds invest 65/35 in Debt and Equity Funds.

6. Real Estate Funds/ETF

These funds invest in physical assets such as gold, platinum, silver, oil, commodities and real estate. Gold Exchange Traded Funds (ETFs) and Real Estate Investment Trusts (REITs) fall within the category of real asset funds.

Investment Philosophy

1. Diversified Equity Funds

These funds diversify the equity component of their Asset Under Management (AUM), across various sectors. Such funds avoid taking sectorial bets i.e. investing more of their assets towards a particular sector such as oil & gas, construction, metals etc. Thus, they use the diversification strategy to reduce their overall portfolio risk.

2. Sector Funds

These funds are expected to invest predominantly in a specific sector. For instance, a banking fund will invest only in banking stocks. Generally, such funds invest 65% of their total assets in a respective sector.

3. Index Funds

These funds seek to have a position which replicates the index, say BSE Sensex or NSE Nifty. They maintain an investment portfolio that replicates the composition of the chosen index, thus following a passive style of investing.

4. Exchange Traded Funds (ETFs)

These funds are open-ended funds which are traded on the exchange (BSE / NSE). These funds are benchmarked against the stock exchange index. For example, funds traded on the NSE are benchmarked against the Nifty. The Benchmark Nifty BeES is an example of an ETF which links to the stocks in the Nifty. Unlike an index fund where the units are traded at the day's NAV, in ETFs (since they are traded on the exchange) the price keeps on changing during the trading hours of the exchange. If you as an investor want to buy or sell ETF units, you can do so by placing orders with your broker, who will in-turn offer a two-way real time quote at all times. The AMC does not offer sale and re-purchase for the units. Today, ETFs are available for pre-specified indices. We also have Gold ETFs. Silver ETFs are not yet available.

5. Fund of Funds (FOF)

These funds invest their money in other funds of the same mutual fund house or other mutual fund houses. They are not allowed to invest in any other FOF and they are not entitled to invest their assets other than in mutual fund schemes/funds, except to such an extent where the fund requires liquidity to meet its redemption requirements, as disclosed in the offer document of the FOF scheme.

6. Fixed Maturity Plan (FMP)

These funds are basically income/debt schemes like Bonds, Debentures and Money market instruments. They give a fixed return over a period of time. FMPs are similar to close ended schemes which are open only for a fixed period of time during the initial offer. However, unlike closed ended schemes where your money is locked for a particular period, FMPs give you an option to exit. Remember though, that this is subject to an exit load as per the funds regulations. FMPs, if listed on the exchange, provide you with an opportunity to liquidate by selling your units at the prevailing price on the exchange. FMPs are launched in the form of series, having different maturity profiles. The maturity period varies from 3 months to one year.

7. Equity Linked Savings Scheme (ELSS)

These are basically diversified equity funds with a lock-in period of three years. Investment made under these type of funds qualify for deduction under section 80-C of the Income Tax Act, 1961. As compared to many other tax saving schemes, these type of schemes have an upper hand as :-

  • The lock-in period is only three years;
  • Possibility of getting much superior return;
  • Tax free dividend;
  • No capital gain tax on redemption, etc

Geographic Regions

1. Country or Region Funds

These funds invest in securities (equity and/or debt) of a specific country or region with an underlying belief that the chosen country or region is expected to deliver superior performance, which in turn will be favourable for the securities of that country. The returns on country fund are affected not only by the performance of the market where they are invested, but also by changes in the currency exchange rates.

2. Offshore Funds

These funds mobilise money from investors for the purpose of investment within as well as outside their home country.

So we have seen that funds can be categorised based on tenure, investment philosophy, asset class, or geographic region. Now, let's get down to simplifying some jargon with the help of a few definitions, before getting into understanding the nitty-gritty of investing in mutual funds.

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