Investment in mutual funds has attracted millions of investors over decades. The recent post covid era saw an unprecedented rush of investors towards mutual funds trying to tap the market boom and gaining maximum advantage along the way. Among the multiple available mutual funds options, equity mutual funds are considered to be the most riskier and at the same time provide maximum returns.
Given below is the meaning of equity mutual funds and the various options available under the same.
What are equity mutual funds?
Equity mutual funds as the name suggests are funds that invest mainly in equity and equity-related instruments. As per SEBI guidelines, a fund needs to invest a minimum of 65% of the fund in equity and equity-related instruments to qualify as an equity mutual fund. These funds are highly volatile and also provide maximum capital appreciation to the investors. Equity funds are ideal for aggressive investors that have a long-term investment horizon which helps them gain the maximum advantage of the funds’ returns. The expense ratio of equity mutual funds is higher as compared to debt mutual funds but the higher expenses are also compensated by higher returns. The expertise and experience of the highly qualified fund managers allow the funds to meet the ultimate goal of the fund which is maximizing investors’ wealth.
What are the features of equity mutual funds?
Some of the prime features of an equity mutual fund are highlighted hereunder.
- Higher risk
Equity funds are highly volatile funds which means that they are highly affected due to market volatility. When the market is on a high, these funds can generate higher returns but when the market is on a downward trend, equity funds are impacted the most and have the potential to wipe out the entire capital investment of the investors.
- Inflation beating returns when investing for long term
One of the greatest advantages of equity mutual funds is that the fund returns have the potential to beat inflation. When most traditional investment options like Bank FDs, Post office Schemes, etc. provide returns that can barely match inflation, equity mutual funds can provide returns that are quite higher than such traditional investment options and at the same time have the potential to beat the inflation even after the deduction of taxes.
- Capital appreciation
Capital appreciation refers to the increase in the base capital of the investors on account of higher returns. Equity funds have the potential to provide maximum capital appreciation due to higher returns and lower taxes as compared to debt mutual funds.
- Liquidity
Another crucial feature of equity mutual funds is their liquidity. Like any other mutual funds, equity mutual funds are also highly liquid and can be redeemed without any lock-in period (except in the case of ELSS funds).
- Investment horizon
The usual investment horizon of equity mutual funds is approximately 5 to 7 years to allow the funds an opportunity to generate maximum returns for the investors. Therefore, investors with a similar investment horizon and a higher risk appetite can include these funds in their portfolios to maximize their overall returns.
- Tax benefit
The taxation on equity mutual funds is on the two forms of income from the funds namely the dividends and the capital gains. The dividends from the fund are taxed in the hands of the investors at their applicable tax rates. The capital gains on the other hand are taxed based on their period of holding. Short-term capital gains (STCG) are taxed at the flat rate of 15% whereas long-term capital gains (LTCG) are taxed at a flat rate of 10% after the initial exemption up to Rs. 1,00,000.
What are the types of equity mutual funds?
Equity funds can be classified into various categories based on multiple parameters. The details of the same are mentioned hereunder.
- Based on market capitalization
The types of equity funds based on their market capitalization are detailed hereunder.
- Large-Cap equity funds
These funds invest 80% of the fund in large-cap stocks. These stocks belong to the companies that rank between 1 to 100 in terms of market capitalization on any stock exchange. Large-cap funds are less volatile as compared to small-cap or mid-cap funds and also provide relatively stable returns. These stocks are highly liquid and have a medium-term investment horizon.
- Mid-Cap equity funds
These funds invest a minimum of 65% of their funds in stocks of mid-cap companies. Such companies are the companies that rank between 101 to 250 as per market capitalization on recognized stock exchanges. These funds are more volatile as compared to large-cap funds but not as much as small-cap funds. The returns from these funds are also relatively higher than that of large-cap funds. The usual investment horizon of these funds is medium to long term.
- Small-Cap equity funds
These funds invest a minimum of 65% of the fund in small-cap companies. Small-cap companies are the companies that rank above 250 in terms of market capitalization on the stock exchanges. These funds are highly volatile and also have the potential to provide maximum returns to investors when the market is on an upward trend. The downside of these funds is the limited liquidity and the potential of making steep losses during a recession.
- Large and Mid-Cap equity funds
This fund invests in a blend of large-cap companies and mid-cap companies. As per SEBI guidelines, a fund needs to invest a minimum of 35% in stocks of large-cap companies and 35% in the stock of mid-cap companies. These funds, therefore, form a good mix of assets that can provide higher returns at the same time balance the overall risk of the fund.
- Multi-Cap equity funds
These funds invest in stock from all three categories of companies namely, large-cap, mid-cap, and small-cap. The investment in each type of equity should be a minimum of 25% and the overall investment in equities should be a minimum of 75% of the total corpus of the fund.
- Based on investment strategy
- Thematic funds
Thematic funds are also known as sectoral funds. These funds target a particular sector and invest a minimum of 80% of the fund in the stock of such sector. The risk of such funds is quite higher but they have the potential to provide better returns when the sector is on a bullish trend.
- Focused equity funds
These funds invest in maximum 30 stocks of based on the parameters and other terms and conditions as mentioned in the Scheme Information Document (SID). The fund needs to invest a minimum of 65% of its corpus in equities and equity-related instruments. The target investments of the fund can be across companies based on market capitalization, sectors, etc.
- Contra funds
Funs that invest based on contrarian investment strategy are referred to as contra funds. The investment strategy involves the analysis of the market and locating under-performing stocks. The fund managers purchase such stocks at low rates with the assumption that these stocks will recover over time.
- Dividend yield funds
Dividend yield funds are the funds that invest a minimum of 65% of the fund in dividend-yielding stocks. These funds are ideal for investors that prefer more or less stable income from their mutual fund investments and also have a lower risk appetite.
- Value funds
Value funds are different than dividend-yielding funds and focus on wealth creation rather than providing regular income to the investors. The fund needs to invest a minimum of 65% of its corpus in stocks that focus on a value investing strategy.
- Based on tax benefit
- ELSS funds
ELSS funds or Equity Linked Savings Scheme are commonly known as tax saving funds and are the number one choice of investors that focus on tax saving as well as wealth creation. The fund provides a tax exemption to the investors up to Rs. 1,50,000 under section 80C of the Income Tax Act, 1961. These funds have all the features of equity funds along with a minimum lock-in period of 3 years.
Conclusion
Equity mutual funds are a popular mutual fund category and allow the users to have an opportunity for maximum wealth creation. The high-risk high return profile of these funds makes them ideal for aggressive investors. Equity funds can be active funds where there is a huge involvement of the fund managers or passive funds that simply track an index for its performance. The huge array of options from the equity funds category allows all types of investors to benefit from mutual fund investments.
FAQs
The two main modes of investment in equity mutual funds are the lump sum investment mode and the SIP mode.
The main factors to be considered for mutual funds investment are investment budget, investment horizon as well as the risk-return perception of the investors.
The maximum expense ratio of equity mutual funds as per SEBI guidelines is 2.25%
Equity mutual funds are taxed based on the investment period. Short-term capital gains are taxed at a flat rate of 15% and long-term capital gains are taxed at a flat rate of 10% after an exemption of Rs. 1,00,000.
