Types of Mutual Fund Schemes

Mutual funds are not a one-size-fits-all investment. Different schemes are designed to meet different financial goals, investment horizons, and risk profiles.

Mutual fund schemes can be broadly classified based on their structure, portfolio management approach, investment objective, underlying assets, and investment strategy.

How Mutual Fund Schemes Are Classified

Mutual fund schemes can broadly be classified based on:

1. Organisation Structure – Open-ended, Close-ended, and Interval Schemes
2. Portfolio Management – Active and Passive Funds
3. Investment Objective – Growth, Income, and Liquidity-oriented schemes
4. Underlying Portfolio – Equity, Debt, Hybrid, Money Market, and Multi-Asset schemes
5. Investment Strategy or Solution – Tax-saving, Retirement, Children's funds, Arbitrage, and other solution-oriented or thematic strategies
6. Exchange Traded Funds (ETFs)
7. Overseas Funds
8. Fund of Funds (FoFs)

Classification by Organisation Structure

The structure of a mutual fund determines when investors can buy or redeem units.

Open-Ended Schemes

Open-ended schemes do not have a fixed maturity period. Investors can generally purchase or redeem units on an ongoing basis on business days at the applicable NAV, subject to the scheme's terms.

This makes open-ended funds a commonly used structure for investors who want flexibility in entering or exiting their investments.

Close-Ended Schemes

Close-ended schemes have a defined maturity period. Units are generally offered to investors during the initial subscription period and are redeemed at maturity, subject to applicable scheme provisions.

Units of close-ended schemes are listed on stock exchanges to provide investors with an avenue to exit before maturity through the secondary market. However, the ability to sell units before maturity depends on the availability of buyers and prevailing market conditions.

Interval Schemes

Interval schemes allow investors to purchase or redeem units only during specified periods known as transaction periods or intervals.

These schemes combine certain features of open-ended and close-ended structures. The applicable transaction windows and other conditions are specified in the scheme documents.

Active vs Passive Funds

Another important way to classify mutual funds is by how the portfolio is managed.

Active Funds

In an active fund, the fund manager and investment team actively make decisions about which securities to buy, hold, or sell.

The investment team may use different investment strategies, research, and portfolio management styles to construct and manage the portfolio.

Key characteristics include:

• The investment strategy and approach are disclosed in the scheme-related documents.
• The fund manager actively selects securities based on the scheme's investment objective and strategy.
• The objective may be to outperform the scheme's benchmark, although there is no guarantee that the fund will do so.
• The risk and return characteristics depend on the investment strategy, securities selected, and prevailing market conditions.

Passive Funds

Passive funds aim to replicate or closely track a specified index or benchmark rather than actively selecting securities with the objective of outperforming it.

Common examples include:

• Index Funds
• Exchange Traded Funds (ETFs)

The fund manager's role is primarily to ensure that the portfolio tracks the underlying index as closely as possible, while seeking to minimise the tracking difference or tracking error, subject to the scheme's objectives and costs.

Active Funds vs Passive Funds

• Active Funds: Portfolio is actively managed by a fund manager.
• Passive Funds: Portfolio aims to replicate a benchmark index.
• Active Funds: Fund manager selects securities based on the investment strategy.
• Passive Funds: Securities are generally determined by the underlying index.
• Active Funds: May aim to outperform the benchmark.
• Passive Funds: Generally aims to track the benchmark.
• Active Funds: Returns may differ significantly from the benchmark.
• Passive Funds: Performance generally remains close to the benchmark, subject to tracking difference and costs.
• Active Funds: Usually involve relatively higher management costs.
• Passive Funds: Generally have lower expense ratios than comparable active strategies.

The choice between active and passive funds depends on an investor's objectives, preferences, risk tolerance, and investment approach.

Classification by Investment Objective

Mutual fund schemes can also be classified according to what they aim to achieve.

Common investment objectives include:

1. Capital Appreciation
2. Capital Preservation
3. Regular Income
4. Liquidity
5. Tax Saving

The appropriate scheme depends on factors such as the investor's financial goal, investment horizon, risk appetite, and prevailing market conditions.

Growth-Oriented Funds

Growth-oriented schemes primarily aim to provide capital appreciation over the investment horizon.

Such schemes may invest substantially in growth-oriented assets, including equities, depending on their investment mandate.

Key characteristics:

• Focus on long-term capital appreciation.
• Often suitable for investors with a medium- to long-term investment horizon.
• Equity-oriented investments can experience significant short-term fluctuations.
• Investors should be prepared to tolerate market volatility and the possibility of losses.

While equities have historically provided the potential for higher long-term returns than several traditional asset classes, past performance does not guarantee future results.

Income-Oriented Funds

Income-oriented schemes generally seek to generate income through investments in fixed-income securities.

These may include instruments such as:

• Corporate bonds
• Debentures
• Government securities
• Other permitted fixed-income instruments

Returns may come from interest income as well as changes in the market value of the securities held by the scheme.

However, income or returns are not guaranteed. The performance of such schemes can be influenced by factors including interest rates, credit quality, maturity, and market conditions.

Liquid, Overnight and Money Market Funds

Liquid, overnight, and money market schemes are generally designed for investors looking to invest in short-term instruments, with the specific investment mandate varying by scheme.

Overnight Funds

Overnight funds invest in securities having a maturity of one day. They are designed for very short-term investment needs.

Liquid Funds

Liquid funds primarily invest in short-term money market and debt instruments with maturities within the limits prescribed for the category.

They may be considered by investors looking to deploy surplus funds for relatively short periods, subject to the risks associated with the scheme.

Money Market Funds

Money market funds invest in money market instruments with a maturity of up to one year, in accordance with the applicable regulatory framework.

The returns from these schemes are influenced by prevailing short-term interest rates and market conditions.

These schemes may be considered for short-term investment requirements, but they are not guaranteed-return or risk-free products.

Money market instruments may include instruments such as commercial paper, commercial bills, treasury bills, certificates of deposit, call or notice money, government securities with an applicable maturity of up to one year, and other instruments permitted under the relevant regulations.

Classification by Investment Portfolio

Mutual fund schemes can also be understood based on the assets and securities that make up their portfolios.

Asset Class

At the broadest level, schemes can invest in different asset classes, including:

• Equity
• Debt
• Money Market Instruments
• Gold and other permitted commodities
• A combination of multiple asset classes

Investment Strategy

Within each asset class, schemes may follow different investment strategies.

For example, equity schemes may focus on:

• Large-cap companies
• Mid-cap companies
• Small-cap companies
• Value investing
• Specific sectors or themes

Debt schemes may follow strategies based on factors such as:

• Duration
• Credit quality
• Interest-rate outlook
• Dynamic allocation across maturities

The portfolio composition of a mutual fund ultimately follows the investment objective and strategy of the scheme.

Other Types of Mutual Fund Schemes

Apart from the classifications above, investors may also come across several specialised categories.

Hybrid Funds

Hybrid funds invest across more than one asset class, such as equity and debt. The allocation depends on the specific category and investment strategy of the scheme.

Multi-Asset Funds

Multi-asset funds invest across multiple asset classes, providing exposure to a diversified combination of investments within the framework of the scheme.

Arbitrage Funds

Arbitrage funds seek to benefit from price differences between related securities or markets. Their risk and return characteristics differ from those of conventional equity funds.

Tax-Saving Funds

Equity Linked Savings Schemes (ELSS) are equity-oriented mutual fund schemes that offer eligible investors a tax deduction under applicable provisions of the Income Tax Act, subject to prevailing tax laws and limits. ELSS investments have a mandatory lock-in period of three years.

Exchange Traded Funds (ETFs)

ETFs are mutual fund schemes that are traded on stock exchanges during market hours, similar to listed securities. Many ETFs aim to track an index, although ETFs can follow different investment strategies.

Overseas Funds

These schemes invest, subject to applicable regulations and their investment mandate, in securities or funds outside India. Their performance may be affected not only by the underlying investments but also by currency movements and international market conditions.

Fund of Funds

A Fund of Funds (FoF) invests primarily in other mutual fund schemes or funds rather than directly investing in individual securities, subject to its stated investment objective.

Choosing the Right Type of Mutual Fund

With so many categories and strategies available, the right mutual fund is not necessarily the one with the highest past return.

Investors should consider:

• What is the financial goal?
• How long do you plan to stay invested?
• How much risk can you comfortably take?
• Which asset class suits your objective?
• How much volatility can you tolerate?
• What are the costs and tax implications?

Understanding how different mutual fund schemes work can help you select investments that are better aligned with your financial goals and investment horizon.

Mutual fund investments are subject to market risks. Read all scheme-related documents carefully before investing.