Objectives and Categorization of MF Schemes

Objectives:

1. Equity Funds

Objective: To generate long-term capital appreciation by investing primarily in equity and equity-related instruments. These funds aim to harness the potential of high growth in the stock market over a longer period.

2. Debt Funds

Objective: To provide regular income and capital preservation by investing in a mix of government and corporate bonds, debentures, and other fixed-income securities. These funds are less volatile compared to equity funds and aim to generate steady returns.

3.Hybrid Funds

Objective: To achieve a balanced mix of income, capital appreciation, and risk by investing in both equity and debt instruments. These funds aim to provide a diversified portfolio, balancing the growth potential of equities with the stability of debt.

4. Index Funds

Objective: To replicate the performance of a specific stock market index, such as the Nifty 50 or Sensex, by investing in the same securities as the underlying index. These funds aim to provide returns that closely match the index performance, offering a low-cost investment option.

5. Sectoral/Thematic Funds

Objective: To achieve capital appreciation by investing in a specific sector or theme, such as technology, healthcare, or infrastructure. These funds target high growth potential sectors but come with higher risk due to their concentrated portfolio.

6. ELSS (Equity Linked Savings Scheme)

Objective: To offer tax benefits under Section 80C of the Income Tax Act while aiming for long-term capital growth by investing predominantly in equities. These funds have a lock-in period of three years, providing both investment growth and tax savings.

7. Liquid Funds

Objective: To provide high liquidity and safety of capital by investing in short-term money market instruments with a maturity of up to 91 days. These funds aim to offer better returns than traditional savings accounts while maintaining low risk.

8. Gilt Funds

Objective: To generate returns by investing exclusively in government securities across various maturities. These funds aim to provide a safe investment avenue with minimal credit risk, focusing on interest income from government bonds.

9. International Funds

Objective: To provide diversification and potential growth by investing in foreign markets and global companies. These funds aim to leverage international opportunities and spread risk across different economies and sectors.

10. Balanced Advantage Funds

Objective: To dynamically manage the asset allocation between equity and debt based on market conditions to optimize returns while managing risk. These funds aim to provide stability and growth by adjusting the equity-debt mix according to market valuations. These objectives help investors choose the right fund category based on their financial goals, risk tolerance, and investment horizon.

Categorization:

As per SEBI guidelines on Categorization and Rationalization of schemes issued in October 2017, mutual fund schemes are classified as –

1. Equity Schemes
2. Debt Schemes
3. Hybrid Schemes
4. Solution Oriented Schemes – For Retirement and Children
5. Other Schemes – Index Funds & ETFs and Fund of Funds
– Under Equity category, Large, Mid and Small cap stocks have now been defined.
– Naming convention of the schemes, especially debt schemes, as per the risk level of underlying portfolio (e.g., the erstwhile ‘Credit Opportunity Fund’ is now called “Credit Risk Fund”)
– Balanced / Hybrid funds are further categorised into conservative hybrid fund, balanced hybrid fund and aggressive hybrid fund.

EQUITY SCHEMES

Equity Fund Categories as per SEBI guidelines on Categorization and Rationalization of schemes

Multi Cap Fund*

At least 75% investment in equity & equity related instruments

Flexi Cap Fund

At least 65% investments in equity & equity related instruments

Large Cap Fund

At least 80% investment in large cap stocks

Large & Mid Cap Fund

At least 35% investment in large cap stocks and 35% in mid cap stocks

Mid Cap Fund

At least 65% investment in mid cap stocks

Small cap Fund

At least 65% investment in small cap stocks

Dividend Yield Fund

Predominantly invest in dividend yielding stocks, with at least 65% in stocks

Value Fund Value

investment strategy, with at least 65% in stocks

Contra Fund

Scheme follows contrarian investment strategy with at least 65% in stocks

Focused Fund

Focused on the number of stocks (maximum 30) with at least 65% in equity & equity related instruments

Sectoral/ Thematic Fund

At least 80% investment in stocks of a particular sector/ theme

ELSS

At least 80% in stocks in accordance with Equity Linked Saving Scheme, 2005, notified by Ministry of Finance

*Also referred to as Diversified Equity Funds – as they invest across stocks of different sectors and segments of the market. Diversification minimizes the risk of high exposure to a few stocks, sectors or segment.

SECTOR SPECIFIC FUNDS

Sectoral funds invest in a particular sector of the economy such as infrastructure, banking, technology or pharmaceuticals etc.
– Since these funds focus on just one sector of the economy, they limit diversification, and are thus riskier.
– Timing of investment into such funds are important, because the performance of the sectors tend to be cyclical.
Examples of Sector Specific Funds – Equity Mutual Funds with an investment objective to invest in
Pharma & Healthcare Sector
Banking & Finance Sector:
FMCG (fast moving consumer goods) and related sectors.
Technology and related sectors

THEMATIC FUNDS

VALUE FUNDS (STRATEGY AND STYLE BASED FUNDS)

Equity funds may be categorized based on the valuation parameters adopted in stock selection, such as

CONTRA FUNDS

Contra funds are equity mutual funds that take a contrarian view on the market.
Underperforming stocks and sectors are picked at low price points with a view that they will perform in the long run.
The portfolios of contra funds have defensive and beaten down stocks that have given negative returns during bear markets.
These funds carry the risk of getting calls wrong as catching a trend before the herd is not possible in every market cycle and these funds typically underperform in a bull market.
As per the SEBI guidelines on Scheme categorisation of mutual funds, a fund house can either offer a Contra Fund or a Value Fund, not both.

EQUITY LINKED SAVINGS SCHEME (ELSS)

ELSS invests at least 80% in stocks in accordance with Equity Linked Saving Scheme, 2005, notified by Ministry of Finance.

DEBT SCHEMES

A debt fund (also known as income fund) is a fund that invests primarily in bonds or other debt securities.

Debt funds invest in short and long-term securities issued by government, public financial institutions, companies, Treasury bills, Government Securities, Debentures, Commercial paper, Certificates of Deposit and others

Debt funds can be categorized based on the tenor of the securities held in the portfolio and/or on the basis of the issuers of the securities or their fund management strategies, such as

Debt funds have potential for income generation and capital preservation.

Debt Fund Categories as per SEBI guidelines on Categorization and Rationalization of schemes

Overnight Fund

Overnight securities having maturity of 1 day

Liquid Fund

Debt and money market securities with maturity of upto 91 days only

Ultra Short Duration Fund

Debt & Money Market instruments with Macaulay duration of the portfolio between 3 months – 6 months

Low Duration Fund

Investment in Debt & Money Market instruments with Macaulay duration portfolio between 6 months- 12 months

Money Market Fund

Investment in Money Market instruments having maturity upto 1 Year

Short Duration Fund

Investment in Debt & Money Market instruments with Macaulay duration of the portfolio between 1 year – 3 years

Medium Duration Fund

Investment in Debt & Money Market instruments with Macaulay duration of portfolio between 3 years – 4 years

Medium to Long Duration Fund

Investment in Debt & Money Market instruments with Macaulay duration of the portfolio between 4 – 7 years

Long Duration Fund

Investment in Debt & Money Market Instruments with Macaulay duration of the portfolio greater than 7 years

Dynamic Bond

Investment across duration

Corporate Bond Fund

Minimum 80% investment in corporate bonds only in AA+ and above rated corporate bonds

Credit Risk Fund

Minimum 65% investment in corporate bonds, only in AA and below rated corporate bonds

Banking and PSU Fund

Minimum 80% in Debt instruments of banks, Public Sector Undertakings, Public Financial Institutions and Municipal Bonds

Gilt Fund

Minimum 80% in G-secs, across maturity

Gilt Fund

with 10 year constant Duration Minimum 80% in G-secs, such that the Macaulay duration of the portfolio is equal to 10 years

Floater Fund

Minimum 65% in floating rate instruments (including fixed rate instruments converted to floating rate exposures using swaps/ derivatives)

Dynamic Bond funds alter the tenor of the securities in the portfolio in line with expectation on interest rates. The tenor is increased if interest rates are expected to go down and vice versa

Floating rate funds invest in bonds whose interest are reset periodically so that the fund earns coupon income that is in line with current rates in the market, and eliminates interest rate risk to a large extent.

Short-Term Debt Funds

The primary focus of short-term debt funds is coupon income. Short term debt funds have to also be evaluated for the credit risk they may take to earn higher coupon income. The tenor of the securities will define the return and risk of the fund. Funds holding securities with lower tenors have lower risk and lower return.

Short-Term Fund combine coupon income earned from a pre-dominantly short-term debt portfolio with some exposure to longer term securities to benefit from appreciation in price.

Fixed Maturity Plans (FMPs)

FMPs are closed-ended funds which eliminate interest rate risk and lock-in a yield by investing only in securities whose maturity matches the maturity of the fund.
FMPs create an investment portfolio whose maturity profile match that of the FMP tenor.
Potential to provide better returns than liquid funds and Ultra Short Term Funds since investments are locked in
Low mark to market risk as investments are liquidated at maturity.
Investors commit money for a fixed period.
Investors cannot prematurely redeem the units from the fund
FMPs, being closed-end schemes are mandatorily listed – investors can buy or sell units of FMPs only on the stock exchange after the NFO.
Only Units held in dematerialized mode can be traded; therefore investors seeking liquidity in such schemes need to have a demat account.

Capital Protection Oriented Funds

Capital Protection Oriented Funds are close-ended hybrid funds that create a portfolio of debt instruments and equity derivatives

The portfolio is structured to provide capital protection and is rated by a credit rating agency on its ability to do so. The rating is reviewed every quarter.
The debt component of the portfolio has to be invested in instruments with the highest investment grade rating.
A portion of the amount brought in by the investors is invested in debt instruments that is expected to mature to the par value of the capital invested by investors into the fund. The capital is thus protected.
The remaining portion of the funds is used to invest in equity derivatives to generate higher returns.

HYBRID FUNDS

Hybrid funds Invest in a mix of equities and debt securities.

SEBI has classified Hybrid funds into 7 sub-categories as follows:

Conservative Hybrid Fund

10% to 25% investment in equity & equity related instruments; and 75% to 90% in Debt instruments

Balanced Hybrid Fund

40% to 60% investment in equity & equity related instruments; and 40% to 60% in Debt instruments

Aggressive Hybrid Fund

65% to 80% investment in equity & equity related instruments; and 20% to 35% in Debt instruments

Dynamic Asset Allocation or Balanced Advantage Fund

Investment in equity/ debt that is managed dynamically (0% to 100% in equity & equity related instruments; and 0% to 100% in Debt instruments)

Multi Asset Allocation Fund

Investment in at least 3 asset classes with a minimum allocation of at least 10% in each asset class

Arbitrage Fund

Scheme following arbitrage strategy, with minimum 65% investment in equity & equity related instruments

Equity Savings

Equity and equity related instruments (min.65%); debt instruments (min.10%) and derivatives (min. for hedging to be specified in the SID)

Solution-oriented & Other funds

Retirement Fund

Lock-in for at least 5 years or till retirement age whichever is earlier

Children’s Fund

Lock-in for at least 5 years or till the child attains age of majority whichever is earlier

Index Funds/ ETFs

Minimum 95% investment in securities of a particular index

Fund of Funds (Overseas/ Domestic)

Minimum 95% investment in the underlying fund(s)

Hybrid funds

Invest in a mix of equities and debt securities. They seek to find a ‘balance’ between growth and income by investing in both equity and debt.

The regular income earned from the debt instruments provide greater stability to the returns from such funds.
The proportion of equity and debt that will be held in the portfolio is indicated in the Scheme Information Document
Equity oriented hybrid funds (Aggressive Hybrid Funds) are ideal for investors looking for growth in their investment with some stability.
Debt-oriented hybrid funds (Conservative Hybrid Fund) are suitable for conservative investors looking for a boost in returns with a small exposure to equity.
The risk and return of the fund will depend upon the equity exposure taken by the portfolio – Higher the allocation to equity, greater is the risk.

Multi Asset Funds

A multi-asset fund offers exposure to a broad number of asset classes, often offering a level of diversification typically associated with institutional investing.
Multi-asset funds may invest in a number of traditional equity and fixed income strategies, index-tracking funds, financial derivatives as well as commodity like gold.
This diversity allows portfolio managers to potentially balance risk with reward and deliver steady, long-term returns for investors, particularly in volatile markets.

Arbitrage Funds

“Arbitrage” is the simultaneous purchase and sale of an asset to take advantage of the price differential in the two markets and profit from price difference of the asset on different markets or in different forms.

Arbitrage fund buys a stock in the cash market and simultaneously sells it in the Futures market at a higher price to generate returns from the difference in the price of the security in the two markets.
The fund takes equal but opposite positions in both the markets, thereby locking in the difference.
The positions have to be held until expiry of the derivative cycle and both positions need to be closed at the same price to realize the difference.
The cash market price converges with the Futures market price at the end of the contract period. Thus it delivers risk-free profit for the investor/trader.
Price movements do not affect initial price differential because the profit in one market is set-off by the loss in the other market.
Since mutual funds invest own funds, the difference is fully the return.

Hence, Arbitrage funds are considered to be a good choice for cautious investors who want to benefit from a volatile market without taking on too much risk.

Index Funds

Index funds create a portfolio that mirrors a market index.

Investors have the comfort of knowing the stocks that will form part of the portfolio, since the composition of the index is known.

Exchange Traded Funds (ETFs)

An ETF is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund.

ETFs are listed on stock exchanges.
Unlike regular mutual funds, an ETF trades like a common stock on a stock exchange. The traded price of an ETF changes throughout the day like any other stock, as it is bought and sold on the stock exchange.
ETF Units are compulsorily held in Demat mode
ETFs are passively managed, which means that the fund manager makes only minor, periodic adjustments to keep the fund in line with its index
Because an ETF tracks an index without trying to outperform it, it incurs lower administrative costs than actively managed portfolios.
Rather than investing in an ‘active’ fund managed by a fund manager, when one buy units of an ETF one is harnessing the power of the market itself.
Suitable for investors seeking returns similar to index and liquidity similar to stocks.

Fund of Funds (FoF)

Fund of funds are mutual fund schemes that invest in the units of other schemes of the same mutual fund or other mutual funds.
The schemes selected for investment will be based on the investment objective of the FoF
The FoF have two levels of expenses: that of the scheme whose units the FoF invests in and the expense of the FoF itself. Regulations limit the total expenses that can be charged across both levels as follows:
– TER in respect of FoF investing liquid schemes, index funds & ETFs has been capped @ 1%
– TER of FoF investing in equity-oriented schemes has been capped @ 2.25%
– TER of FoF investing in other schemes than mentioned above has been capped @2%.

Gold Exchange Traded Funds (FoF)

Gold ETFs are ETFs with gold as the underlying asset
– The scheme will issue units against gold held. Each unit will represent a defined weight in gold, typically one gram.
– The scheme will hold gold in form of physical gold or gold related instruments approved by SEBI.
– Schemes can invest up to 20% of net assets in Gold Deposit Scheme of banks
– The price of ETF units moves in line with the price of gold on metal exchange.
After the NFO, units are issued to intermediaries called authorized participants against gold or funds submitted. They can also redeem the units for the underlying gold.

Benefits of Gold ETFs

International Funds

International funds enable investments in markets outside India, by holding in their portfolio one or more of the following:
– Equity of companies listed abroad.
– ADRs and GDRs of Indian companies.
– Debt of companies listed abroad.
– ETFs of other countries.
– Units of passive index funds in other countries.
– Units of actively managed mutual funds in other countries.
International equity funds may also hold some of their portfolios in Indian equity or debt.
– They can hold some portion of the portfolio in money market instruments to manage liquidity.
International funds gives the investor additional benefits of
– Diversification, since global markets may have a low correlation with domestic markets.
– Investment options that may not be available domestically.
– Access to companies that are global leaders in their field.
There are risks associated with investing in such funds, such as –
– Political events and macro economic factors that are less familiar and therefore difficult to interpret
– Movements in foreign exchange rate may affect the return on redemption
– Countries may change their investment policy towards global investors.
For the purpose of taxation, these funds are considered as non-equity oriented mutual fund schemes.