Mutual Funds

A mutual fund is an investment vehicle that pools funds from investors

and invests in equities, bonds, government securities, gold, and other
assets. Companies that qualify to set up mutual funds, create Asset
Management Companies (AMCs) or Fund Houses, which pool in the
money from investors, market mutual funds, manage investments, and
enable investor transactions.
Mutual funds are managed by sound financial professionals known as
fund managers, who have the expertise in analyzing and managing
investments. The funds collected from investors in mutual funds are
invested by the fund managers in different financial assets such as
stocks, bonds, and other assets, as defined by the fund’s investment
objective. Where and when to invest are some of the things taken care
of by the fund managers, amongst many other responsibilities.
Types of Mutual Funds
There are multiple ways in which mutual funds can be categorized, for
example, the way they are structured, the kind of securities they hold, their
investment strategies, etc. The Securities and Exchange Board of India
(SEBI) has classified mutual funds based on where they invest, some of which
we have listed below.
• Based on the structure:
1. Open-ended funds are mutual funds that allow you to invest and
redeem investments at any time, i.e. they are perpetual in nature. They
are liquid in nature and don’t come with a specific investment period.
2. Close-ended schemes have a fixed maturity date. You can only invest at
the time of the new fund offer and redemption can only be done on
maturity. You cannot purchase the units of a close-ended mutual fund
whenever you please.
• Based on asset classes:
1. Equity Mutual Funds invest at least 65% of their assets in stocks of
companies listed on the stock exchange. They are more suitable as long-
term investments (> 5 years) as stocks can be volatile in the short term.
They have the potential to offer higher returns but also come with high
risk.
2. Debt Mutual Funds primarily invest in fixed-income instruments like
Government securities, corporate bonds, and other debt instruments.
They are not affected by stock market volatility and hence, can offer
more stable returns compared to equity mutual funds. The types of debt
mutual funds are differentiated on the basis of the maturity period of the
securities they hold.
3. Hybrid Mutual Funds invest in both equity and debt in varying
proportions depending on the investment objective of the fund. Thus,
hybrid funds give you diversified exposure to various asset classes.
Hybrid funds are categorized on the basis of their allocation to equity
and debt.
Mutual Fund Functions
• New fund offer (NFO) release: An AMC can start a mutual fund scheme by
launching its NFO. It creates and shares the strategy of the scheme before its
launch. Investors can then decide whether and how much they should invest. /
• Pooling money: After the NFO, fund houses receive funds from interested
investors to purchase shares in stocks, bonds, and other assets. Investors who
didn’t participate in the NFO can still buy the units of the fund after it gets
operational.
• Investments in securities: The scheme’s strategy determines how the fund
manager will invest the funds. The fund manager does extensive research on the
economy, industries, and companies before making an investment decision. He
then buys the most appropriate securities that will generate optimum returns for
unitholders.
• Return of funds: As mutual funds generate returns, the gains can be distributed
among investors or retained in the scheme for further growth. Investors receive
payouts if they choose the IDCW option (income distribution cum capital
withdrawal). If they choose the growth option, the gains are retained in the
scheme and allowed to grow further.
Mutual Fund Objectives
• Diversification: It is usually advised not to put all your eggs in one basket.
Doing so can disproportionately increase your risk. Mutual funds are
inherently diversified. They diversify across securities, assets, and even
geographies. Hence, they help lower the risk.
• Capital protection: Some mutual funds, such as money-market funds and
liquid funds, aim to protect your capital. However, while they are relatively
safer, they also have lower returns.
• Capital growth: Certain mutual funds, such as equity funds, focus on
growth to protect your investment against inflation. These funds invest in
stocks and have higher returns but also come with higher risks.
• Saving tax: A certain class of mutual funds, called equity-linked savings
schemes (ELSS) or tax-saving funds, also provide income-tax deductions up
to Rs 1.5 lakh in a financial year in the old income-tax regime.
Features & Benefits of Investing in Mutual Funds
• Diversification: The saying ‘do not put all your eggs in one basket’ perfectly fits mutual funds as
spreading investment across multiple securities and asset categories lowers risk. For example,
compared to direct equity investing, where your funds are deployed in individual company stocks,
equity mutual funds invest in a basket of stocks across sectors, thereby reducing risk.
• Professional management: Mutual funds are managed by full-time, professional fund managers
who have the expertise, experience, and resources to actively buy, sell, and manage investments.
A fund manager continuously monitors investments and rebalances the portfolio accordingly to
meet the scheme’s objectives.
• Transparency: Every mutual fund has a Scheme Information Document readily available on the
fund house’s website that can give you all the details about its holdings, fund manager, etc. In
addition, the portfolio investment value (NAV) is published daily on the AMC site, and AMFI site
for investors to track the portfolio of the mutual fund.
• Liquidity: You can redeem your investments on any business/working day at the NAV of the day of
your redemption. So, depending on the type of mutual fund you have invested in, you will receive
your invested funds in your bank account in 1-3 days.
However, close-ended funds allow redemption only at the time of the maturity of the mutual
fund. Similarly, ELSS mutual funds have a lock-in period of three years.
• Tax Savings: Investment of up to Rs. 1,50,000 in ELSS mutual funds qualifies for tax benefit under
section 80C of the Income Tax Act, 1961. Mutual fund investments, when held for a longer term,
are tax-efficient.
• Choice: There are many options to invest in mutual funds to meet your different
needs. To name a few- Liquid funds, are for investors looking to benefit from the
safety of debt and low-interest rate risk, flexi-cap funds if you are looking for
stock diversification, and solution-oriented mutual funds if you are looking to
invest for a particular goal like retirement or children’s education, etc.
• Cost-effective: Mutual funds are a low-cost investment vehicle. The pooled
investments from several investors in a mutual fund enable the fund to invest in a
basket of stocks and debt securities which otherwise may be out of reach for the
ordinary investor or require a higher investment amount. Thus, these pooled
investments provide advantages of economies of scale. In return, lower costs to
investors, such as brokerage, etc., are addressed in the minor form of fund
expenses. This is why investing in direct mutual funds through ET Money makes
sense because that helps you decrease the cost further.
• Returns: Mutual fund returns are not assured by mutual funds and are subject to
market risks. But over the long term, equity mutual funds have the potential to
deliver double-digit returns annually. Debt funds can also offer higher returns as
compared to bank deposits.
• Well Regulated: In India, the mutual fund industry is regulated by the capital
market regulator Securities and Exchange Board of India (SEBI). Therefore, mutual
funds must follow stringent rules and regulations, ensuring investor protection,
risk mitigation, liquidity, and fair valuation.
 Disadvantages of Mutual Funds
• Exit Load: Mutual funds generally levy an exit load (fee) for redeeming investments within a
specified time period, for example, one year from the date of investment. This is done to refrain
the investor from exiting the scheme too early, as it impacts both the fund’s performance and the
investor’s goal achievement. When investing directly in stocks, say, you do not face any exit load
and in comparison, this may seem like an added expense. However, this has been introduced in
the investors’ interest.
• High cost: SEBI has defined the maximum limit of expense ratios that mutual fund houses can
charge and they depend on the mutual fund’s size. As the size grows, the expense tends to come
down. The maximum expense ratio that is chargeable for an equity-oriented mutual fund is
2.25%. And you have to bear this charge irrespective of the performance of the fund. When
compared to another mode of investment, say, direct stocks, you may find the expense ratio to be
higher than the brokerage you pay. But then it is being paid for the convenience and expertise, so,
it is a balance that you need to achieve.
• Over-diversification: In the quest to diversify your investments, you may invest in mutual funds,
which invest in a vast number of stocks, leading to over-diversification. Not all the stocks of a
portfolio would deliver high returns all the time. You may end up investing in two mutual funds
holding similar portfolios which may then lead to over-diversification. It is advisable to study the
mutual fund portfolio before you invest.
• Risk: Investments in mutual funds are subject to market risk. The risk of losses faced by all types
of securities in the financial markets cannot be reduced by diversification. Market risks may occur
due to many macro and microeconomic factors. For example, equity mutual funds are subject to
volatility risk owing to fluctuations in the stock market whereas debt mutual funds are subject to
interest rate risk which is caused by fluctuations in the interest rates and so on.