Part 17 Mutual Funds Made Easy Types Pros Cons Charges
Part 17 - Mutual Funds Made Easy: Types, Pros, Cons, and Charges
Complete Guide to Mutual Fund Types: Equity, Debt, Hybrid & More
Types of Mutual Funds
Mutual funds are classified based on structure, asset class, investment objective, risk profile, and specialty.
Below are the primary types relevant in India and globally, with explanations.
1. Based on Structure
Open-Ended Funds:
Explanation:
Open-ended mutual funds allow investors to buy or sell units at any time, meaning there are no restrictions on entry or exit (unlike closed-ended funds with fixed maturity or lock-in periods).
However, the transaction price is based on the Net Asset Value (NAV), which is calculated at the end of each trading day based on the closing prices of the fund’s underlying assets.
Example: HDFC Flexi Cap Fund (India), Vanguard S&P 500 Index Fund (Global).
Closed-Ended Funds:
Explanation: Fixed number of units issued via a New Fund Offer (NFO). Traded on stock exchanges post-NFO, often at a premium/discount to NAV. Fixed maturity period.
Example: ICICI Prudential Bharat 22 FOF (India).
Interval Funds:
Explanation: Hybrid of open- and closed-ended funds. Allow transactions only during specific intervals (e.g., quarterly). Less common.
Example: Rare in India; more common in global bond funds.
2. Based on Asset Class
Equity Mutual Funds (Stock-based)
Equity Funds:
Explanation: Invest primarily in stocks. Sub-types include large-cap, mid-cap, small-cap, multi-cap, and sectoral/thematic funds (e.g., technology, banking).
Example: SBI Bluechip Fund (India), Fidelity Contrafund (Global).
Debt Funds:
Explanation: Invest in fixed-income securities like bonds, treasury bills, and corporate debentures. Sub-types include liquid funds, short-term funds, and gilt funds.
Example: Aditya Birla Sun Life Liquid Fund (India), PIMCO Total Return Fund (Global).
Hybrid Funds:
Explanation: Invest in a mix of equity and debt. Sub-types include balanced advantage funds, aggressive hybrid funds, and conservative hybrid funds.
Example: ICICI Prudential Balanced Advantage Fund (India), American Funds Balanced Fund (Global).
Money Market Funds:
Explanation: Invest in short-term, low-risk instruments like treasury bills and commercial papers. Focus on liquidity and safety.
Example: Tata Money Market Fund (India), Fidelity Government Cash Reserves (Global).
Index Funds:
Explanation: Track a market index (e.g., Nifty 50, S&P 500). Passive management with low costs.
Example: UTI Nifty 50 Index Fund (India), SPDR S&P 500 ETF Trust (Global).
Exchange-Traded Funds (ETFs):
Explanation: Track indices but trade like stocks on exchanges. Can cover equity, debt, or commodities (e.g., gold ETFs).
Example: Nippon India ETF Nifty BeES (India), iShares Core S&P 500 ETF (Global).
3. Based on Investment Objective
Growth Funds:
Explanation: Focus on capital appreciation through equity investments. High risk, long-term horizon.
Example: Mirae Asset Emerging Bluechip Fund (India).
Income Funds:
Explanation: Aim for regular income via debt securities. Lower risk, suitable for conservative investors.
Example: SBI Dynamic Bond Fund (India).
Tax-Saving Funds (ELSS):
Explanation: Equity-linked savings schemes with a 3-year lock-in, offering tax benefits under Section 80C (India-specific).
Example: Axis Long Term Equity Fund (India).
Liquid Funds:
Explanation: Invest in ultra-short-term debt instruments (maturity up to 91 days). High liquidity, low risk.
Example: HDFC Liquid Fund (India).
4. Based on Specialty
Sectoral/Thematic Funds:
Explanation: Invest in specific sectors (e.g., pharma, IT) or themes (e.g., ESG, infrastructure).
Example: ICICI Prudential Technology Fund (India), ARK Innovation ETF (Global).
International/FoF (Fund of Funds):
Explanation: Invest in foreign markets or other mutual funds. FoFs allocate across multiple funds for diversification.
Example: Motilal Oswal Nasdaq 100 FoF (India), BlackRock Global Allocation Fund (Global).
Solution-Oriented Funds:
Explanation: Designed for specific goals like retirement or children’s education. Often have lock-in periods.
Example: Tata Retirement Savings Fund (India).
Advantages of Each Type
Open-Ended Funds:
India/Global: High liquidity (redeem anytime at NAV). Flexible investment via SIPs or lump sums.
Closed-Ended Funds:
India/Global: Fund managers can focus on long-term strategies without redemption pressure. Potential for higher returns in niche markets.
Equity Funds:
India/Global: High return potential over the long term (e.g., 12-15% CAGR in India for large-cap funds). Diversification across stocks reduces risk.
Debt Funds:
India/Global: Stable returns (5-8% in India for liquid/short-term funds). Lower volatility than equity. Suitable for short-term goals.
Hybrid Funds:
India/Global: Balanced risk-reward profile. Automatic asset allocation suits investors unsure about equity vs. debt.
Money Market Funds:
India/Global: High safety and liquidity. Ideal for parking surplus funds (4-6% returns in India).
Index Funds/ETFs:
India/Global: Low expense ratios (0.1-0.5% in India). Track market performance, reducing manager risk.
Tax-Saving Funds (ELSS):
India: Tax deduction up to ₹1.5 lakh under Section 80C. Equity exposure offers high returns (12-15% CAGR over 10 years).
Sectoral/Thematic Funds:
India/Global: High returns during sector booms (e.g., IT funds in India returned 20%+ in 2020-21).
International/FoFs:
India/Global: Geographic diversification. Access to global markets (e.g., U.S. tech via Nasdaq 100 FoF).
Solution-Oriented Funds:
India: Goal-based investing (e.g., retirement) encourages disciplined saving.
Disadvantages of Each Type
Open-Ended Funds:
India/Global: Susceptible to redemption pressure during market downturns, impacting NAV. Higher management fees than ETFs.
Closed-Ended Funds:
India/Global: Limited liquidity (traded on exchanges, often at a discount/premium to NAV). Lock-in reduces flexibility.
Equity Funds:
India/Global: High volatility (e.g., mid/small-cap funds in India fell 30-40% in 2018-19). Not suitable for short-term goals.
Debt Funds:
India: Credit and liquidity risks (e.g., Franklin Templeton debt fund crisis 2020). Interest rate changes impact returns.
Global: Lower returns than equity (3-5% in developed markets). Sensitive to rate hikes.
Hybrid Funds:
India/Global: Moderate returns (8-10% in India) compared to pure equity. Complex allocation may confuse investors.
Money Market Funds:
India/Global: Low returns (4-6% in India, 1-3% globally). Not ideal for long-term wealth creation.
Index Funds/ETFs:
India/Global: Limited to market returns; no outperformance potential. Sectoral downturns impact returns (e.g., Nifty 50 fell 26% in 2020 crash).
Tax-Saving Funds (ELSS):
India: 3-year lock-in reduces liquidity. High equity exposure means volatility.
Sectoral/Thematic Funds:
India/Global: High risk due to concentrated exposure. Sector downturns lead to heavy losses (e.g., infra funds in India underperformed 2010-15).
International/FoFs:
India: Currency risk (INR depreciation impacts returns). Higher expense ratios (1-2% for FoFs).
Global: Geopolitical risks and higher fees for cross-border investments.
Solution-Oriented Funds:
India: Lock-in periods (5-15 years) limit flexibility. Moderate returns due to hybrid nature.
Costs Associated with Mutual Funds
Mutual fund costs impact net returns and vary by type. Below are the key cost components in India and globally, with approximate ranges.
Expense Ratio (Total Expense Ratio - TER):
Explanation: Annual fee covering management, administrative, and operational costs, expressed as a percentage of AUM.
India:
Equity Funds: 1-2.5% (e.g., 1.8% for active large-cap, 0.5% for index funds).
Debt Funds: 0.5-1.5% (e.g., 0.3% for liquid funds).
ETFs/Index Funds: 0.1-0.5%.
FoFs: 1-2% (higher due to underlying fund fees).
Global:
Active Funds: 0.5-1.5% (e.g., 1% for U.S. equity funds).
Index Funds/ETFs: 0.03-0.5% (e.g., 0.04% for Vanguard S&P 500 ETF).
Impact: A 1% higher TER can reduce returns by 10-15% over 20 years due to compounding.
Exit Load:
Explanation: Fee charged for redeeming units within a specified period (e.g., 1 year).
India:
Equity Funds: 0-1% if redeemed within 1 year (e.g., 1% for SBI Bluechip Fund).
Debt Funds: 0-0.5% for early redemption (e.g., liquid funds typically nil).
ELSS: No exit load (3-year lock-in).
Global: Less common in open-end funds; some funds charge 0.25-1% for early withdrawals.
Impact: Discourages short-term trading but reduces net returns if redeemed early.
Entry Load:
Explanation: Fee charged at the time of investment.
India: Abolished by SEBI in 2009.
Global: Rare in modern funds; some U.S. funds charge 1-5% as front-end loads.
Impact: Reduces initial investment amount if applicable.
Transaction Charges:
Explanation: One-time fee for investments above a threshold.
India: ₹100-150 for investments ≥ ₹10,000 (first-time investors); ₹100 for SIPs ≥ ₹10,000.
Global: Brokerage fees for ETFs (e.g., $5-10 per trade in the U.S.).
Impact: Minimal but adds to costs for frequent transactions.
Other Costs:
India:
Securities Transaction Tax (STT): 0.001% on equity fund redemptions.
GST: Applied on expense ratio (18% on management fees).
Global:
12b-1 Fees (U.S.): 0.25-1% for marketing/distribution.
Capital Gains Tax: Varies by country (e.g., 15-20% in U.S. for long-term gains).
Impact: Indirectly reduces returns, especially in high-fee funds.
Cost Comparison by Type
Low-Cost Funds: Index Funds, ETFs, Liquid Funds (TER: 0.1-0.5% in India, 0.03-0.3% globally).
High-Cost Funds: Sectoral/Thematic, FoFs, Active Equity Funds (TER: 1-2.5% in India, 0.8-1.5% globally).
India-Specific: Direct plans (no distributor commission) have lower TER (e.g., 0.8% vs. 1.8% for regular plans). Regular plans dominate retail investments, increasing costs.
Key Observations
Indian Context: Equity funds dominate AUM (₹34.66 trillion, 56.5% of total AUM as of June 2024), followed by debt (₹14.33 trillion, 23.4%). Low-cost index funds and ETFs are gaining traction (₹2.36 trillion AUM). SEBI’s push for transparency (e.g., TER disclosure) helps investors, but high fees in regular plans remain a concern.
Global Context: Passive funds (index/ETFs) account for ~50% of U.S. mutual fund assets due to low costs (e.g., 0.04% TER for Vanguard ETFs). Active funds struggle to justify higher fees (1-1.5%) given 80% underperform benchmarks over 10 years.
Cost Impact: In India, a 1% TER difference on a ₹1 lakh investment growing at 10% CAGR over 20 years reduces returns by ~₹1.5 lakh. Globally, low-cost ETFs are preferred for long-term investing.
Mutual Fund Types Summary Table -
