Equity Funds invest in different shares of different companies. They are high-risk mutual funds that are invested with the aim to generate higher returns. Equity funds generate better returns than debt-based funds or term deposits. The performance of these funds is dependent on numerous market conditions due to which they come attached with high risks.
An equity mutual fund can be categorised as a mutual fund scheme when it invests more than 60% of its total assets in the equity shares of distinct companies. The remaining 40% can be invested in debt securities or money market instruments.
Types of Equity Mutual Funds
Equity funds can be categorised on different basis. These have been explained below:
Based on Investment Strategy
- Focused equity funds can at maximum invest in 30 stocks of companies that have specified market capitalization at the time of launch.
- Contra equity funds follow the contrarian strategy of investing. The scheme analyses the market in order to spot the under-performing stocks. These stocks are then purchased with an assumption that they will recover in the long run, thus fetching greater returns.
- Theme and sectoral funds follow a specific theme, for example, emerging market or international stock. Some schemes invest only in particular sectors of the market like IT, BFSI, etc. It must be noted that such theme-based and sectoral funds carry higher risk with them as they focus on a particular sector or theme.
Based on Market Capitalisation
- Large-cap funds are the ones investing a minimum of 80% of the total assets available. The investment is made in the equity shares of the top 100, large-cap companies. These are more stable than the mid-cap and small-cap funds.
- Mid-cap funds invest around 65% of the total assets. The investment is made in 101-250th placed mid-cap companies. These companies are ranked as per their market capitalisation. They offer better returns than large-cap funds but they are also more volatile.
- Small-cup funds invest around 65% of their total assets in the equity shares of 251st and below ranked companies. There are more than 95% of companies in India that fall under this category. They offer higher returns than large-cap and mid-cap funds but their volatility is also greater.
- Multi-cap funds invest around 65% of their total assets in the equity shares of large-cap, mid-cap and small-cap companies. The investment is made in varying proportions. The portfolio is continuously rebalanced by the fund managers. This is done to match the market conditions, economic conditions and investment objectives.
Based on Investment Style
- Active funds are actively managed by the fund managers. The stocks that they wish to invest in are handpicked by them.
- Passive funds track the market index which determines the list of the stock that the scheme will be investing in. The fund manager plays no active role in selecting the stocks.
Based on Tax Treatment
- Equity Linked Savings Scheme (ELSS) offers tax benefits of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. Under this scheme, an investment of 80% of the total assets in equity and related instruments is made. The lock-in period under this scheme is three years.
- Non-Tax Saving Equity Funds are subject to capital gains tax. It should be noted that except ELSS all the other funds are non-tax saving schemes.
Benefits of Investing in Equity Funds
- Even though one must keep a close eye on his/her risk appetite while investing in equity funds, it comes with a lot of benefits.
- Equity funds are professionally managed by the fund managers who are market experts. They are responsible for studying and analysing the market trends and the performance of different companies. After the analysis, they invest into the most promising stocks which would fetch the investor great returns.
- It is cost-effective and easy on the pocket. Investments in equity funds can also be made using Systematic Investment Plan (SIP). SIP allows weekly, bi-weekly, monthly or quarterly investment as low as Rs.500. It also helps in tackling the volatility of the equity market.
- Portfolio diversification is another advantage. So, even if certain stocks underperform you can achieve gains from other well-performing stocks.
- Equity funds offer liquidity, this is because the units can be redeemed anytime on any business day through the applicable NAVs. However, ELSS funds are an exception to this.
- Tax benefits are another prime advantage of equity funds. Investing in ELSS offers tax deduction under Section 80C of the Income Tax Act 1961.
It must be noted that before making an investment you should assess your risk appetite, financial goals and read the terms and conditions carefully before investing. It is very important to understand the nature of the scheme and stocks before the money is pooled by the scheme and invested in the stocks.