Closed-End Mutual Funds
A closed-end mutual fund has a set number of shares issued to the public through an initial public offering. These funds have a stipulated maturity period generally ranging from 3 to 15 years. The fund is open for subscription only during a specified period. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where they are listed.
Once underwritten, closed-end funds trade on stock exchanges like stocks or bonds. The market price of closed-end funds is determined by supply and demand and not by net-asset value (NAV), as is the case in open-end funds. Usually closed mutual funds trade at discounts to their underlying asset value.
Distinct Features of Closed-end Funds
- These funds are closed to new capital after they begin operating
- Closed-end funds trade on stock exchanges rather than being redeemed directly by the fund
- Unlike open-end funds, the closed-end funds can be traded during the market day at any time. Open-end funds are generally traded at the closing price at the end of the market day.
- Closed-end funds are usually traded at a premiuim or discount whereas open-end funds are traded at NAV.
Advantages of Closed-end Funds
- Closed-end funds don't have to worry about the redemption of shares, hence they tend to keep less cash in their portfolios and cam invest more capital in the market. Therefore, they have the potential to generate greater returns as compared to open-end funds.
- In case of market panic and mass-selling by investors, open-end funds need to raise money for redemptions. To cope with the liquidity concerns, the manager of an open-ended fund may be forced to sell stocks he would rather keep, and keep stocks he would rather sell. In such as scenario the quality of the portfolio may be affected.
Open End Mutual Fund
Open end funds are operated by a mutual fund house which raises money from shareholders and invests in a group of assets, as per the stated objectives of the fund. Open-end funds raise money by selling shares of the fund to the public, in a manner similar to any other company, which sell its stock to raise the capital. An open-end mutual fund does not have a set number of shares. It continues to sell shares to investors and will buy back shares when investors wish to sell. Units are bought and sold at their current net asset value.
Open-end funds are required to calculate their net asset value (NAV) daily. Since the NAV of an open-end fund is calculated daily, it serves as a useful measure of its fair market value on a per-share basis. The NAV of the fund is calculated by dividing the fund's assets minus liabilities by the number of shares outstanding. Open-end funds usually charge an entry or exit load from the investors.
Most of the open-end funds are actively managed and the fund manager picks the stocks as per the objective of the fund. Open-end funds keep some portion of their assets in short-term and money market securities to provide available funds for redemptions. A large portion of most open mutual funds is invested in highly liquid securities, which enables the fund to raise money by selling securities at prices very close to those used for valuations.
Some of the benefits of open-end funds include diversification, professional money management, liquidity and convenience. But open-end funds have one negative as compared to closed-end funds. Since open-end funds are constantly under redemption pressure, they always have to keep a certain amount of money in cash, which they otherwise would have invested. This lowers the potential returns.
Large Cap Funds
Large cap funds are those mutual funds, which seek capital appreciation by investing primarily in stocks of large blue chip companies with above-average prospects for earnings growth.
Different mutual funds have different criteria for classifying companies as large cap. Generally, companies with a market capitalisation in excess of Rs 1000 crore are known large cap companies. Investing in large caps is a lower risk-lower return proposition (vis-à-vis mid cap stocks), because such companies are usually widely researched and information is widely available.
Large cap funds invest in those companies that have more potential of earning growth and higher profit. One of the major advantages of large cap funds is that they are less volatile than mid cap and small cap funds and the near term prospects of large cap funds can be more accurately predicted. On the flip side, the large cap funds offer lower returns than mid cap or small cap funds. But when compared in totality, large cap funds outperform all other funds. These funds come under low risk low return category. In volatile times it is advisable to invest in large cap funds.
Top Large cap Funds in India
- HDFC Top 200
- UTI Large Cap Fund
- Franklin India Blue Chip
- Kotak 30
- DSPML Top 100 Equity
- Principal Large Cap Fund
- Reliance Growth Fund
Mid Cap Funds
Mid cap funds are those mutual funds, which invest in small / medium sized companies. As there is no standard definition classifying companies as small or medium, each mutual fund has its own classification for small and medium sized companies. Generally, companies with a market capitalization of up to Rs 500 crore are classified as small. Those companies that have a market capitalization between Rs 500 crore and Rs 1,000 crore are classified as medium sized.
Big investors like mutual funds and Foreign Institutional Investors are increasingly investing in mid caps nowadays because the price of large caps has increased substantially. Small / mid sized companies tend to be under researched thus they present an opportunity to invest in a company that is yet to be identified by the market. Such companies offer higher growth potential going forward and therefore an opportunity to benefit from higher than average valuations. Mid cap companies are looked upon as wealth creators and have the potential to join the league of large cap companies. Such companies are nimble, flexible and can adapt to the changes faster. One of the challenges that fund managers of mid cap funds face is to identifying such companies.
But mid cap funds are very volatile and tend to fall like a pack of cards in bad times. So, caution should be exercised while investing in mid cap mutual funds. Mid cap funds are a good option in case the investor wants to add some diversity to his portfolio.
Top Mid Cap Funds in India
- Sundaram BNP Paribas Select Midcap
- Franklin India Prima Fund
- HDFC Capital Builder
- Kotak Indian Mid Cap Fund
- HSBC Midcap Equity Fund
Balanced fund is also known as hybrid fund. It is a type of mutual fund that buys a combination of common stock, preferred stock, bonds, and short-term bonds, to provide both income and capital appreciation while avoiding excessive risk.
Balanced funds provide investor with an option of single mutual fund that combines both growth and income objectives, by investing in both stocks (for growth) and bonds (for income). Such diversified holdings ensure that these funds will manage downturns in the stock market without too much of a loss. But on the flip side, balanced funds will usually increase less than an all-stock fund during a bull market.
Advantages of Balanced Fund
- Generally, balanced funds maintain a 60:40 equity debt ratio. This means that 60% of their total investment is in equity and the balance 40% in debt and cash equivalents. Balance funds combine the power of equities (shares) and the stability of debt market instruments (fixed return investments like bonds) and provide both income and capital appreciation while avoiding excessive risk.
- Balanced funds continuously rebalance their portfolios to ensure that the broad asset allocation is not disturbed. Therefore, the profits earned from the stock markets are encashed and invested in low risk instruments. This helps the investor in maintaining the appropriate asset mix, without getting into the hassles of rebalancing the portfolio on their own.
Equity Mutual Funds
Equity mutual funds are also known as stock mutual funds. Equity mutual funds invest pooled amounts of money in the stocks of public companies. Stocks represent part ownership, or equity, in companies, and the aim of stock ownership is to see the value of the companies increase over time. Stocks are often categorized by their market capitalization (or caps), and can be classified in three basic sizes: small, medium, and large. Many mutual funds invest primarily in companies of one of these sizes and are thus classified as large-cap, mid-cap or small-cap funds.
Equity fund managers employ different styles of stock picking when they make investment decisions for their portfolios. Some fund managers use a value approach to stocks, searching for stocks that are undervalued when compared to other similar companies. Another approach to picking is to look primarily at growth, trying to find stocks that are growing faster than their competitors, or the market as a whole. Some managers buy both kinds of stocks, building a portfolio of both growth and value stocks. Since equity funds invest in stocks, they have the potential to generate more returns. On the other hand they carry greater risks too. Equity funds can be classified into diversified equity funds and sectoral equity funds.
How to Select an Equity Fund
Compare a fund with its peers:
One of the basic fundamental of benchmarking is to evaluate funds with in the same category. For example, if you are evaluating the performance of a thematic fund, say IT based fund, then you should compare its performance with another similar IT based fund. Comparing it with banking sector fund for example will not give the correct picture. Comparing a fund over stock market cycle (boom and bust) will give investors a good idea about how the fund has fared.
Compare returns against those of the benchmark index:
Every fund mentions a benchmark index in the Offer Document. It can be BSE 100, BSE 200, Nifty or any other index. The benchmark index serves as a guidepost for both the fund manager and the investor. Compare how the fund has fared against the benchmark index over a period of 3-5 years. The funds that have outperformed their benchmark indices during stock market volatility must be given a close look.
Compare against the fund's own performance:
Apart from comparing a fund with its peers and benchmark index, investors should evaluate its historical performance. By evaluating a fund against its own historical performance, you can get an idea about consistent performers.
Exchange Traded Funds
Exchange Traded Funds (ETFs) represent a basket of securities that is traded on an exchange, similar to a stock. Hence, unlike conventional mutual funds, ETFs are listed on a recognised stock exchange and their units are directly traded on stock exchange during the trading hours. In ETFs, since the trading is largely done over stock exchange, there is minimal interaction between investors and the fund house. ETFs can be categorised into close-ended ETFs or open-ended ETFs.
ETFs are either actively or passively managed. Actively managed ETFs try to outperform the benchmark index, whereas passively-managed ETFs attempt to replicate the performance of a designated benchmark index.
Difference Between ETF and Conventional Mutual Funds
- Mutual funds are traded through fund house where as in an ETF, transactions are done through a broker as buying and selling is done on the stock exchange.
- In conventional mutual funds units can be bought and redeemed only at the relevant NAV, which is declared only once at the end of the day. ETFs can be bought and sold at any time during market hours like a stock. As a result, ETF investors have the benefit of real time pricing and they can take advantage of intra-day volatility.
- Annual expenses charged to investors in an ETF are considerably less than the vast majority of mutual funds. Most of the mutual funds have an entry or exit load varying between 2.00% and 2.25%. ETFs do not have any such loads. Instead ETF investors have to pay a brokerage to the broker while transacting. which in most cases is not more than 0.5%.
- ETFs safeguard the interests of long-term investors. This is because ETFs are traded on exchange and fund managers do have to keep cash in hand in order to meet redemption pressures
Fund of Funds
A fund of funds (FoF) is an investment fund that holds a portfolio of other investment funds rather than investing directly in shares, bonds or other securities. This type of investment is also known as multi-manager investment. Fund of funds can be classified into: Mutual fund FoF and Hedge fund FoF.
Mutual fund FoF:
A Mutual fund FoF invests in other mutual funds. Just as a mutual fund invests in a number of different securities, a fund of funds holds shares of many different mutual funds.
Hedge fund FoF:
A Hedge fund FoF invests in a portfolio of different hedge funds to provide broad exposure to the hedge fund industry and to diversify the risks associated with a single investment fund.
Pros & Cons of Fund of funds
Fund of funds are designed to achieve greater diversification than traditional mutual funds. But on the flipside, expense fees on fund of funds are typically higher than those on regular funds because they include part of the expense fees charged by the underlying funds. Also, since a fund of funds buys many different funds which themselves invest in many different stocks, it is possible for the fund of funds to own the same stock through several different funds and it can be difficult to keep track of the overall holdings.
Growth funds are those mutual funds that aim to achieve capital appreciation by investing in growth stocks. They focus on those companies, which are experiencing significant earnings or revenue growth, rather than companies that pay out dividends. Growth funds tend to look for the fastest-growing companies in the market. Growth managers are willing to take more risk and pay a premium for their stocks in an effort to build a portfolio of companies with above-average earnings momentum or price appreciation.
In India, growth funds became popular after the tremendous growth of the Indian companies during the post economic reforms period. The rapid growth of Indian industry attracted investors' money to sectors of high growth and as a result growth funds came into being.
Objective of Growth Funds
The objective of growth funds is to achieve capital appreciation by in stocks of those companies, which are registering significant earnings or revenue growth. Growth funds offer tremendous opportunities for growth, when the financial market is bullish.
In general, growth funds are more volatile than other types of funds, rising more than other funds in bull markets and falling more in bear markets. Only aggressive investors, or those with enough time to make up for short-term market losses, should buy these funds.
No-Load Mutual Funds
Mutual funds can be classified into two types - Load mutual funds and No-Load mutual funds. Load funds are those funds that charge commission at the time of purchase or redemption. They can be further subdivided into (1) Front-end load funds and (2) Back-end load funds.
Front-end load are fees or expenses recovered by mutual funds against compensation paid to brokers, their distribution and marketing costs. These expenses are generally called as sales loads. Front-end load funds charge commission at the time of purchase. Similar to front end loads there are back end loads. Back-end load funds charge commission at the time of redemption.
no-load funds are those funds that can be purchased without commission. No load funds have several advantages over load funds. Firstly, funds with loads, on average, consistently underperform no-load funds when the load is taken into consideration in performance calculations. Secondly, loads understate the real commission charged because they reduce the total amount being invested. Finally, when a load fund is held over a long time period, the effect of the load, if paid up front, is not diminished because if the money paid for the load had been invested, as in a no-load fund, it would have been compounding over the whole time period.
Value funds are those mutual funds that tend to focus on safety rather than growth, and often choose investments providing dividends as well as capital appreciation. They invest in companies that the market has overlooked, and stocks that have fallen out of favour with mainstream investors, either due to changing investor preferences, a poor quarterly earnings report, or hard times in a particular industry.
Investing in value fund involves identifying fundamentally sound stocks that are trading at a discount to their fair value. The fund manager buys these stocks and holds them until the stock bounce backs to its fair value. The fund managers identify undervalued stocks in the market on the basis of fundamental analysis techniques. In this process stocks with low price to earnings ratios are tagged. These stocks are then closely reviewed to see which ones have the greatest growth potential and are paying high dividends.
Negatives of Value Funds
Though value funds are perceived as safe investments, since they have low volatility and are long-term investments, in reality it may not be so. These undervalued stocks can trade at discounted prices for an extended period of time, thereby reducing the amount of return relative to the risk associated with the investment.
Suitability of Value Funds
Value style of investing works particularly well during a bear phase in the stock markets. During this time, the fund manager has more opportunities to invest in stocks trading at a discount to their fair value. By buying low and selling high, value funds take on lower risk than growth funds, which tend to buy high and sell higher. Thus value funds are particularly suitable for investors with a moderate risk profile. As value funds react slowly to market movements, they can be a good instrument of investment for those investors who are due to retire shortly.
Money Market Mutual Funds
A money market fund is a mutual fund that invests solely in money market instruments. Money market instruments are forms of debt that mature in less than one year and are very liquid. Treasury bills make up the bulk of the money market instruments. Securities in the money market are relatively risk-free.
Money market funds are generally the safest and most secure of mutual fund investments. The goal of a money-market fund is to preserve principal while yielding a modest return. Money-market mutual fund is akin to a high-yield bank account but is not entirely risk free. When investing in a money-market fund, attention should be paid to the interest rate that is being offered.
Types of Money Market Mutual Funds
Money market funds are of two types:
1. Institutional Money Market Mutual Funds:
These funds are held by governments, institutional investors and businesses etc. Huge sum of money is parked in institutional money funds.
2. Retail Money Market Mutual Funds:
Retail money market funds are used for parking money temporarily. The investment portfolio of money market funds comprises of treasury bills, short term debts, tax free bonds etc.
Special Features of Money Market Mutual Funds
- Money market mutual funds are one of the safest instruments of investment for the retail low income investor. The assets in a money market fund are invested in safe and stable instruments of investment issued by governments, banks and corporations etc.
- Generally, money market instruments require huge amount of investments and it is beyond the capacity of an ordinary retail investor to invest such large sums. Money market funds allow retail investors the opportunity of investing in money market instrument and benefit from the price advantage.
Money market mutual funds are usually rated by the rating agencies. So, check for the fund ratings before investing.
An index fund is a a mutual fund or exchange-traded fund) that aims to replicate the movements of an index of a specific financial market. An Index fund follows a passive investing strategy called indexing. It involves tracking an index say for example, the Sensex or the Nifty and builds a portfolio with the same stocks in the same proportions as the index. The fund makes no effort to beat the index and in fact it merely tries to earn the same return.
Origin of Index Funds
Index funds first came into being in the US in the 1970s. In the US the research established the efficient markets concept which says that stocks are mostly priced accurately and that it is not possible to beat the market in a systematic way. Though a few actively managed mutual funds may beat the market for a while, it is very rare for active funds to beat the market in the long run.
Advantages of Index Funds
- As per efficient markets concept index funds provide optimum returns in the long run.
- An index fund doesn't have to pay for expensive analysts and frequent trading.
- Index funds track a broad index which is less volatile than specific stocks or sectors, thereby lessening the risk for investors.
Index Funds in the context of India
In the Indian market scenario index funds may not be the best option. The basic principle of indexing is - the more the number of stocks comprising an index the better is the diversification and price discovery. Indian indices like the Sensex (30) and the Nifty (50) cover a relatively small number of stocks and ignore many opportunities in the mid-cap sector. Also, unlike the capital markets in developed countries, Indian markets haven't been thoroughly researched and there is enormous scope to beat the market by sound research.
International Mutual Funds
International mutual funds are those funds that invest in non-domestic securities markets throughout the world. Investing in international markets provides greater portfolio diversification and let you capitalize on some of the world's best opportunities. If investments are chosen carefully, international mutual fund may be profitable when some markets are rising and others are declining.
However, fund managers need to keep close watch on foreign currencies and world markets as profitable investments in a rising market can lose money if the foreign currency rises against the dollar. In recent years international mutual funds have gained popularity. This can be attributed to removal of trade barriers and expansion of economies, which has sparked off growth in various regions of the world.
Things to Consider Before Investing in International Mutual Funds
International Investing Formula:
According to a survey, the best policy for investment is to have a 70% domestic investment and a 30% international diversified funds investment. The survey reveals that this investment strategy is better than having a 100% domestic investment portfolio or a 100% international exposure in terms of risk exposure and return on the capital.
Not all the markets of the world move in one pack, so a downswing in a country's market can be well taken care off by gains in the others. So, it is essential to have diversification in different markets across the world.
Currency Exchange Risk:
You should also factor in foreign exchange currency fluctuations in your investment returns. For example you invested INR 9000 in an international mutual fund. At that time let say one dollar was worth Rs 45.00. This means in effect you invested $200. After an year your investment appreciated to Rs 10,000 but at the same time dollar appreciated to Rs. 50. So due to fluctuation in dollar-rupee rate, your investment is still worth $200
In addition to these considerations, it is advisable to aware of political history and current events before investing in international mutual funds
Regional Mutual Fund
Regional mutual fund is a mutual fund that confines itself to investments in securities from a specified geographical area, usually, the fund's local region. A regional mutual fund generally looks to own a diversified portfolio of companies based in and operating out of its specified geographical area. The objective is to take advantage of regional growth potential before the national investment community does. They may be some regional funds whose objective is to invest in a specific segment of the region's economy, such as banking, energy etc.
For the investor, the primary benefit of a regional fund is that he/she increases his/her diversification by being exposed to a specific foreign geographical area. For the average investor, these funds are beneficial as most investors don't have enough capital to adequately diversify themselves across many investments in the region.
Regional funds select securities that pass geographical criteria. Regional funds differ from the international mutual funds in the sense that international mutual funds have a diversified portfolio with investment spanning all across the world, where as regional funds invest in companies in one specific region or nation. Regional funds carry more risk as compared to international mutual funds because their investments are less diversified geographically.
Sector Mutual Funds
Sector mutual funds are those mutual funds that restrict their investments to a particular segment or sector of the economy. Also known as thematic funds, these funds concentrate on one industry such as infrastructure, banking, technology, energy, real estate, power heath care, FMCG, pharmaceuticals etc. The idea is to allow investors to place bets on specific industries or sectors, which have strong growth potential.
These funds tend to be more volatile than funds holding a diversified portfolio of securities in many industries. Such concentrated portfolios can produce tremendous gains or losses, depending on whether the chosen sector is in or out of favour. Sectoral mutual funds come in the high risk high reward category and are not suitable for investors having low risk apetite.
Generally, mutual fund houses avoid launching sectoral funds as they are seasonal in nature and do well only in cycles. Since these funds focus on just one sector of the economy, they limit diversification and the fund manager's ability to capitalise on other sectors, if the specific sectors aren't doing well. Unless a particular sector is doing very well and its long term growth prospects look bright, it advisable not to trade in sector funds.
Closed-End Mutual Funds