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Mutual Funds

What are Mutual Funds?

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Mutual funds are investment vehicles that pool money from multiple investors to purchase a diversified portfolio of securities such as stocks, bonds, and other assets. Managed by professional fund managers, mutual funds offer investors the advantage of diversification, professional management, and economies of scale. 

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Benefits of Investing in Mutual Funds

 

Diversification: Reduces risk by spreading investments across various assets.

Professional Management: Experienced fund managers handle the investment decisions.

Liquidity: Easy to buy and sell, providing high liquidity.

Economies of Scale: Lower transaction costs due to pooled resources.

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Risks of investing in Mutual funds

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Market Risk: Investments are subject to market fluctuations.

Credit Risk: Risk of issuer default in debt funds.

Interest Rate Risk: Changes in interest rates affect bond prices.

Management Risk: Poor management decisions can impact fund performance.

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Importance of Goal-Based Investing

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Creating financial goals and investing accordingly is crucial for achieving financial stability and growth. It helps in planning for significant life events like retirement, children's education, or buying a house. Goal-based investing ensures that your investments are aligned with your risk tolerance, time horizon, and financial objectives.

 

7 Things to consider When Selecting a Mutual Fund Scheme

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  • Investment Goals: Define your financial objectives and timeline for achieving them.

  • Risk Tolerance: Assess how much risk you are willing to take based on your age, financial situation, and comfort level.

  • Fund Performance: Evaluate the historical performance of the mutual fund to understand its potential returns.

  • Expense Ratio: Consider the fees charged by the fund, as lower expenses can enhance overall returns.

  • Investment Strategy: Understand the fund's approach to investing, whether it aligns with your goals and risk tolerance.

  • Liquidity: Ensure the fund provides sufficient liquidity, allowing you to withdraw funds when needed without significant penalties.

  • Fund Manager Expertise: Research the experience and track record of the fund manager managing the mutual fund.

 

How Goalstox Can Help

 

At Goalstox, we are committed to helping you achieve your financial goals through personalized investment strategies. Unlike merely an online transaction platform, we offer comprehensive support including offline discussions to tailor your investment plans. Our expertise in goal-based investing, mutual funds, and financial planning ensures you get the best advice and support for your financial journey.

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SEBI Categorization of Mutual Fund Schemes

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In October 2017, SEBI (Securities and Exchange Board of India) issued guidelines on the categorization and rationalization of mutual fund schemes. According to these guidelines, mutual funds are classified into the following categories:

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  • Equity Schemes

  • Debt Schemes

  • Hybrid Schemes

  • Solution-Oriented Schemes (for retirement and children's benefits)

  • Other Schemes (including Index Funds, ETFs, and Fund of Funds)

 

Key Changes and Definitions
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  • Within the equity category, stocks are now defined as large-cap, mid-cap, and small-cap.

  • The naming conventions for schemes, particularly debt schemes, have been standardized according to the risk level of the underlying portfolio. For instance, the previous "Credit Opportunity Fund" is now termed "Credit Risk Fund."

  • Balanced/Hybrid funds are further categorized into conservative hybrid funds, balanced hybrid funds, and aggressive hybrid funds.

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Equity Schemes

 

An equity scheme is a fund that:

  • Primarily invests in equities and related instruments.

  • Aims for long-term growth but can be volatile in the short term.

  • Is suitable for investors with a higher risk tolerance and a longer investment horizon.

The main objective of an equity fund is to seek long-term capital appreciation. These funds might focus on specific market sectors or adopt particular investment styles, such as value or growth investing.

 

Equity Fund Categories (as per SEBI guidelines)
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  • Multi Cap Fund: At least 75% in equity and equity-related instruments.

  • Flexi Cap Fund: At least 65% in equity and equity-related instruments.

  • Large Cap Fund: At least 80% in large-cap stocks.

  • Large & Mid Cap Fund: At least 35% in large-cap stocks and 35% in mid-cap stocks.

  • Mid Cap Fund: At least 65% in mid-cap stocks.

  • Small Cap Fund: At least 65% in small-cap stocks.

  • Dividend Yield Fund: Predominantly in dividend-yielding stocks, with at least 65% in stocks.

  • Value Fund: Follows a value investment strategy, with at least 65% in stocks.

  • Contra Fund: Adopts a contrarian investment strategy with at least 65% in stocks.

  • Focused Fund: Concentrates on a maximum of 30 stocks, with at least 65% in equity and equity-related instruments.

  • Sectoral/Thematic Fund: At least 80% in stocks of a particular sector/theme.

  • ELSS (Equity Linked Saving Scheme): At least 80% in stocks in accordance with the Equity Linked Saving Scheme, 2005, as notified by the Ministry of Finance.

 
Sector-Specific Funds

Sectoral funds invest in a particular sector of the economy, such as infrastructure, banking, technology, or pharmaceuticals. These funds can be riskier due to their lack of diversification and the cyclical nature of sector performance. Timing is crucial when investing in sector-specific funds.

 

Thematic Funds

Thematic funds invest in companies within a particular theme, like infrastructure or service industries. These funds are generally more diversified than sectoral funds and thus have a lower risk profile.

 

Value Funds (Strategy and Style-Based Funds)

Equity funds can be categorized based on the valuation strategies used in stock selection:

  • Growth Funds: Target momentum stocks expected to outperform the market.

  • Value Funds: Identify undervalued stocks that are expected to appreciate over time.

 

Contra Funds

Contra funds take a contrarian approach, investing in underperforming stocks and sectors at low price points with the expectation that they will eventually rebound. These funds carry the risk of misjudging market trends and typically underperform in a bull market. According to SEBI guidelines, a fund house can offer either a Contra Fund or a Value Fund, but not both.

 

Equity Linked Savings Scheme (ELSS)

ELSS funds invest at least 80% in stocks and are in compliance with the Equity Linked Saving Scheme, 2005, as notified by the Ministry of Finance. These funds have a lock-in period of three years and are currently eligible for deductions under Section 80C of the Income Tax Act, up to ₹1,50,000.

 
Debt Schemes

Debt funds (also known as income funds) primarily invest in bonds or other debt securities. These funds aim for income generation and capital preservation by investing in short-term and long-term securities issued by the government, public financial institutions, and companies.

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Debt Fund Categories (as per SEBI guidelines)
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  • Overnight Fund: Invests in overnight securities with a maturity of one day.

  • Liquid Fund: Invests in debt and money market securities with a maturity of up to 91 days.

  • Ultra Short Duration Fund: Invests in debt and money market instruments with a Macaulay duration of 3-6 months.

  • Low Duration Fund: Invests in debt and money market instruments with a Macaulay duration of 6-12 months.

  • Money Market Fund: Invests in money market instruments with a maturity of up to one year.

  • Short Duration Fund: Invests in debt and money market instruments with a Macaulay duration of 1-3 years.

  • Medium Duration Fund: Invests in debt and money market instruments with a Macaulay duration of 3-4 years.

  • Medium to Long Duration Fund: Invests in debt and money market instruments with a Macaulay duration of 4-7 years.

  • Long Duration Fund: Invests in debt and money market instruments with a Macaulay duration of more than seven years.

  • Dynamic Bond: Invests across durations based on interest rate expectations.

  • Corporate Bond Fund: At least 80% in AA+ and above-rated corporate bonds.

  • Credit Risk Fund: At least 65% in AA and below-rated corporate bonds.

  • Banking and PSU Fund: At least 80% in debt instruments of banks, PSUs, public financial institutions, and municipal bonds.

  • Gilt Fund: At least 80% in government securities across maturities.

  • Gilt Fund with 10-Year Constant Duration: At least 80% in government securities with a Macaulay duration of 10 years.

  • Floater Fund: At least 65% in floating rate instruments.

 

Specialized Debt Funds
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  • Dynamic Bond Funds: Adjust the duration of the securities in the portfolio based on interest rate movements.

  • Floating Rate Funds: Invest in bonds with periodically reset interest rates.

  • Short-Term Debt Funds: Focus on generating income through coupon payments and may carry varying degrees of credit risk.

 
Hybrid Funds

 

Hybrid funds invest in a mix of equities and debt instruments to balance growth and income. SEBI has classified hybrid funds into several sub-categories:

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  • Conservative Hybrid Fund: 10-25% in equities and 75-90% in debt.

  • Balanced Hybrid Fund: 40-60% in equities and 40-60% in debt.

  • Aggressive Hybrid Fund: 65-80% in equities and 20-35% in debt.

  • Dynamic Asset Allocation or Balanced Advantage Fund: Dynamic allocation between equities and debt.

  • Multi Asset Allocation Fund: Investment in at least three asset classes with a minimum of 10% in each.

  • Arbitrage Fund: Employs an arbitrage strategy with at least 65% in equities.

  • Equity Savings: At least 65% in equities, 10% in debt, and derivatives for hedging.

 
Solution-Oriented and Other Funds
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  • Retirement Fund: Lock-in for at least five years or until retirement, whichever is earlier.

  • Children's Fund: Lock-in for at least five years or until the child reaches adulthood, whichever is earlier.

  • Index Funds/ETFs: At least 95% in securities of a specific index.

  • Fund of Funds (Overseas/Domestic): At least 95% in the underlying fund(s).

 
Hybrid Funds

 

Hybrid funds, as the name suggests, invest in both equities and debt securities. These funds aim to balance growth and stability, offering regular income through debt instruments while seeking capital appreciation through equity investments.

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  • Equity-oriented hybrid funds are suitable for investors looking for growth with some stability.

  • Debt-oriented hybrid funds are ideal for conservative investors seeking better returns with minimal equity exposure.

  • The risk and return of these funds depend on their equity exposure—the higher the allocation to equities, the greater the risk.

 
Multi-Asset Funds

Multi-asset funds offer exposure to a broad range of asset classes, such as equities, fixed income, commodities, and more. These funds aim to balance risk and reward by diversifying across various investments, providing steady, long-term returns.

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Arbitrage Funds

Arbitrage funds leverage price differences between the cash and futures markets to generate returns. They buy stocks in the cash market and simultaneously sell them in the futures market, locking in the price difference. These funds are suitable for cautious investors who want to benefit from market volatility without taking excessive risks.

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Index Funds

Index funds replicate the performance of a specific market index by holding the same securities in the same proportions. These funds are passively managed, aiming to match the returns and risk profile of the underlying index. They typically have lower fees compared to actively managed funds.

 
Exchange-Traded Funds (ETFs)

ETFs track an index, commodity, or basket of assets and are traded on stock exchanges like regular stocks. They offer the combined benefits of diversification and liquidity, making them an attractive option for investors. ETFs incur lower administrative costs and provide real-time pricing.

 
Sector-Specific Funds

Sector-specific funds invest in companies within a particular industry, such as technology, healthcare, or energy. These funds can offer high returns if the chosen sector performs well. However, they are riskier due to their lack of diversification and can be significantly affected by sector-specific trends.

 
Conclusion

Understanding the categorization of mutual funds is crucial for making informed investment decisions. Each category has distinct features, risk levels, and potential returns, catering to different investor needs and preferences. By comprehensively understanding these categories, investors can align their choices with their financial goals and risk tolerance, ensuring a balanced and diversified investment portfolio.

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Investing in mutual funds is like navigating a financial maze, where every turn presents unique opportunities and challenges. With SEBI's structured framework, this maze becomes easier to navigate, guiding investors towards their desired financial destination.

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Whether you're a risk-averse investor seeking stability or an adventurous one chasing high returns, there's a mutual fund category tailored just for you. Explore your options, understand your risk appetite, and embark on a journey towards financial growth and security.

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