Mutual funds are very popular among investors due to their diversified nature. But what should be your asset allocation between different types of mutual funds?
The answer is different for different investors as each investor has different risk and reward preference depending on their financial goals.
Generally speaking, there are three types of mutual funds. This classification is based on different categories of underlying securities.
- equity funds invest in stocks
- debt funds invest in bonds
- hybrid funds invest in stocks and bonds
When you compare different types of mutual funds, debt funds have lower risk whereas equity funds have higher risk. Hybrid funds are placed in between equity funds and debt funds.
Equity Funds Meaning
What is an equity fund? By definition, equity funds invest most of their corpus in the stocks of publicly traded companies. This includes preferred stock, common stock or other securities that can be converted to common stock.
The best time to invest in equity funds is during bullish stock market. But before choosing best equity funds you should always compare the performance of different types of mutual funds.
Large cap, mid cap and small cap equity funds invest in the companies on the basis of their market capitalization. Index funds and ETF equity funds invest in stocks of the companies which are part of an underlying index.
Dividend equity funds invest in securities which pay high dividends. International equity funds invest in companies of other countries. Income equity funds are best for retirement planning.
The primary objective of equity funds is to provide diversification and capital growth. The equity fund managers invest in growth stocks, value stocks or preferred stocks, with profits and losses shared by mutual fund investors.
Equity funds are highest on risk scale when compared to debt funds or hybrid funds. Within equity funds, sector funds have higher risk than index funds or ETF equity funds.
Actively managed equity mutual funds have higher expense ratio which impacts overall returns whereas passively managed equity mutual funds have lower expense ratio.
Debt Funds Meaning
What is a debt fund? By definition, debt funds invest in high yield bonds, municipal bonds, treasury bonds, corporate bonds, convertible bonds and other fixed income securities.
The average debt fund returns are lower than average equity fund returns. Also debt funds have lower expense ratio and lower risk, in comparison to equity funds and hybrid funds.
The main difference between equity funds and debt funds is that debt funds provide capital protection and regular income to investors. This makes debt funds popular among conservative investors.
How to select a debt fund? Instead of looking for mutual fund tips, you should consult a mutual fund advisor or search the mutual fund database to find out which are the best debt funds to buy.
The biggest advantage of debt funds over individual bonds or equity funds is that debt funds protect the wealth of investors. Also the debt fund management fees are lower than equity funds.
The disadvantage of debt funds is that the average debt fund returns are less than the average returns of equity funds or hybrid funds. Investors should also review the tax on debt funds before investing.
Hybrid Funds Meaning
What is a hybrid fund? By definition, hybrid funds, also known as balanced funds invest in both, stocks and bonds. Mutual fund manager decides whether the hybrid fund portfolio should be conservative or aggressive.
Aggressive hybrid funds are best for investors looking for capital growth whereas conservative hybrid funds are best for conservative investors who are more focused on capital protection.
Hybrid funds are best for retirement planning. But before investing in hybrid funds you should check out the asset allocation, fact sheet, average returns and performance of hybrid funds.
The biggest advantage of hybrid funds is that they provide both, wealth appreciation via stocks and capital protection via bonds. Also hybrid funds have lower management fees than equity funds.
The disadvantage of hybrid funds is that hybrid funds are placed higher on risk scale when compared to debt funds. Also the hybrid fund performance is less than the performance of equity funds.
Types Of Equity Mutual Funds
- Large Cap Equity Funds
- Mid Cap Equity Funds
- Small Cap Equity Funds
- Index Funds
- Exchange Traded Funds (ETF)
- International Equity Funds
- Global Equity Funds
- Domestic Equity Funds
- Emerging Market Equity Funds
- Commodity Equity Funds
- Preferred Equity Funds
- Total Equity Funds
- Market Neutral Equity Funds
- Long Short Equity Funds
- Sector Funds
- Value Funds
- Growth Equity Funds
- Diversified Equity Funds
- Dividend Equity Funds
Large Cap Equity Funds
Large cap funds invest in companies which have large market capitalization. These funds are best for long term growth as these funds offer stability and sustainable returns.
Mid Cap Equity Funds
Mid cap funds invest their corpus in mid size companies, which are still considered as developing companies.
Small Cap Equity Funds
Likewise, small cap funds invest in the stocks of small size companies. These funds are more volatile as compared to large cap or mid cap funds.
Equity index funds invest only in those companies which are part of an underlying index. The value of index fund varies in accordance with rise and fall in benchmark index.
Exchange Traded Funds (ETF)
Exchange traded funds invest their money in stocks of those companies which are part of an underlying index. ETF are very much similar to index funds, but they are listed on exchanges and can be traded like stocks.
International Equity Funds
International funds invest in the stocks of the companies which generate their revenues outside the country.
Global Equity Funds
Global funds invest in the stocks of the companies which do business in the country as well as outside the country.
Domestic Equity Funds
Domestic equity funds invest in the stocks of the companies which have domestic presence in the country.
Emerging Market Funds
Emerging market funds invest in the companies which are present in small but developing markets.
Commodity Equity Funds
Commodity equity funds don’t invest in commodities directly. Instead these types of mutual funds invest in companies that deal with certain commodities in various sectors such as energy or mining.
Preferred Equity Funds
Preferred equity closed end funds or preferred equity ETF invest in preferred stocks of the companies. Preferred stocks are like common stocks as they represent ownership in the company. But they also pay a fixed rate like bonds which makes them less risky than common stocks.
Total Equity Funds
Total equity funds or total equity ETFs try to replicate the broad market by investing in all the stocks that trade on a certain exchange or invest in certain country.
Market Neutral Equity Mutual Funds
Market neutral mutual funds try to mitigate market risk via arbitrage strategies by investing in paired long and short positions.
Long Short Equity Mutual Funds
Long short mutual funds buy the stocks which are expected to go up and short sell the stocks which are expected to go down, thus providing higher returns to investors.
Sector funds, also known as thematic funds, invest in companies of specific sectors like Banking, FMCG, Infrastructure, Pharmaceuticals, Technology, Logistics and Power.
Value funds use value investing as their investment strategy to buy the stocks which are priced below their expected intrinsic value. In other words, these funds try to buy the stocks which they feel are currently undervalued by the market.
Growth Equity Funds
Growth equity funds invest in the stocks that have the potential of giving above average returns to investors. These funds are more volatile during bull markets as well as bear markets than other types of mutual funds.
Diversified Equity Funds
Diversified equity mutual funds reduce the amount of risk by investing in companies across various sectors irrespective of their market capitalization. These types of mutual funds perform best during bear markets.
Dividend Equity Funds
Dividend equity funds invest in high dividend yield companies which have constant cash flows and pay regular dividend to investors.
Types Of Debt Mutual Funds
- Overnight Funds
- Liquid Funds
- Money Market Funds
- Floating Rate Debt Funds
- Ultra Short Term Debt Funds
- Short Term Debt Funds
- Intermediate Term Debt Funds
- Long Term Debt Funds
- Dynamic Debt Funds
- Corporate Debt Funds
- Government Debt Funds
- Municipal Debt Funds
- Credit Risk Funds
- Fixed Maturity Plans
- Junk Debt Funds
- International Debt Funds
- Tactical Debt Funds
- Tax Free Debt Funds
- Inflation Protected Debt Funds
- Unconstrained Debt Fund
- Convertible Debt Funds
- Inverse Debt Funds
- Diversified Debt Funds
- Leveraged Debt Funds
Overnight funds are safe debt funds as they invest in fixed income securities with maturity of one day. Although such funds provide less return, they rank very high on capital protection.
Liquid funds or cash funds provide easy liquidity by investing in treasuries with average maturity of 30 days. The best time to invest in liquid funds is during rising interest rates.
Money Market Funds
Money market funds or treasury mutual funds invest in treasuries and money market instruments with average maturity of less than 90 days.
Floating Rate Debt Funds
Floating rate debt funds mainly invest in debt securities with floating rate. Their value is affected by changing interest rate scenario in debt markets.
Ultra Short Term Debt Funds
These types of mutual funds invest in ultra short term bonds where the residual maturity is less than one year.
Short Term Debt Funds
These types of mutual funds invest in short term bonds where the bond duration is between one year and 3 years.
Intermediate Term Debt Funds
These funds primarily invest in debt securities with a maturity between 3 to 6 years. These funds benefit from capital gains when short term interest rates are high.
Long Term Debt Funds
These funds invest in long term debt securities. They have high debt fund duration as average maturity of the bonds fluctuates between 8 to 10 years.
Dynamic Debt Funds
These funds invest in debt securities across all maturities. These funds are actively managed depending upon the interest rate scenario in bond markets.
Corporate Debt Funds
These funds invest in high yield corporate bonds and securities with different maturities. Corporate debt funds are best for risk seeking investors as they offer higher returns, but are also exposed to higher volatility and credit risk.
Government Debt Funds
Government debt funds invest in different types of government bonds like treasury bonds issued by the government. These funds are highest rated debt funds as they do not have counterparty risk since the issuer is government.
Municipal Debt Funds
Municipal debt funds invest in high yield municipal bonds. These bonds are issued by municipality or state within the country. Municipal debt funds invest in either short term municipal bonds or long term municipal bonds.
Credit Risk Funds
Credit risk funds invest in high yield corporate bonds which have lower credit rating given by rating agencies. These funds carry counterparty risk but provide higher returns.
Fixed Maturity Plans
Fixed Maturity Plans (FMPs) are closed end debt funds where the lock in period can be as low as 3 months or as high as 3 years.
Junk Debt Funds
Junk debt funds invest in high yield corporate bonds which are below investment grade. These bonds give high returns but have junk rating given by rating agencies.
International Debt Funds
International debt funds or foreign debt funds invest in investment grade bonds outside the country. Currency hedged foreign debt funds hedge the currency risk.
Tactical Debt Funds
Tactical debt funds are also known as tactical allocation mutual funds. These funds use tactical asset allocation strategy by investing in different categories of fixed income bonds and generating competitive returns.
Tax Free Debt Funds
Tax free debt funds or tax free income funds invest in tax free bonds. These funds give dividends which aren’t taxed.
Inflation Protected Debt Funds
Inflation protected debt funds, also known as TIPS mutual funds, invest in inflation protected treasuries issued by the government.
Unconstrained Debt Fund
In unconstrained debt fund, the mutual fund manager is not required to adhere to any specific benchmark and can invest across many asset classes and sectors.
Convertible Debt Funds
Convertible debt funds invest in convertible bonds or convertible debt which can be converted into common stock or preferred stock of equivalent value.
Inverse Debt Funds
Inverse debt funds or inverse debt ETF invest in inverse exchange traded funds which profit from falling bond market. These funds appreciate when the price of fixed income index falls.
Diversified Debt Funds
Diversified debt fund is a true core debt fund which invests in bonds across all maturities. They reduce overall portfolio volatility and provide diversification.
Leveraged Debt Funds
Leveraged debt funds are similar to other types of mutual funds but they use leverage as an investment strategy.
Types Of Balanced Mutual Funds
- Aggressive Funds
- Conservative Funds
- Equity Savings Funds
- Fixed Income Funds
- Arbitrage Funds
- Dynamic Asset Allocation Funds
- Multi Asset Allocation Funds
- Gold Mutual Funds
- Silver Mutual Funds
- Target Date Funds
- Alternative Funds
- Fund Of Funds
Aggressive hybrid funds are also known as Equity Oriented Hybrid Funds. They invest 65% to 75% corpus in stocks and 25% to 35% in bonds.
Conservative hybrid funds are also known as Debt Oriented Hybrid Funds. They invest 65% to 75% corpus in bonds and 25% to 35% in stocks. These funds are best for retirement planning.
Equity Savings Funds
These funds invest in equity, debt and arbitrage with minimum of 65% in equities and at least 10% in debt. The asset allocation is decided by mutual fund manager.
Fixed Income Funds
Fixed income mutual funds are best for investors who are looking for income in the form of high dividends. They invest mostly in bonds with little exposure to stocks.
Arbitrage funds maximize their returns by buying the stock at lower price in one market and then selling it at higher price in another market.
Dynamic Asset Allocation Funds
Dynamic asset allocation funds use market timing to manage the proportion of their corpus dynamically between equity and debt instruments.
Multi Asset Allocation Funds
Multi asset allocation funds can invest in multiple asset classes including equity and debt with a minimum investment of 10% in each asset class.
Gold Mutual Funds
Gold funds are open end mutual funds and they invest in Gold Exchange Traded Fund (ETF). It is suitable for investors who want exposure to gold without holding the commodity in physical manner.
Silver Mutual Funds
Silver funds are open end mutual funds and they invest in Silver Exchange Traded Fund (ETF). It is suitable for investors who want exposure to silver without holding the commodity in physical manner.
Target Date Funds
Target date funds are best known as retirement funds. These funds automatically adjust the portfolio shifting from stocks to bonds as retirement date approaches.
Alternative funds do not invest in stocks or bonds. Their investment portfolio includes real estate, commodities, hedge funds, managed futures and derivatives contracts.
Fund Of Funds
Fund of funds invest in different types of mutual funds or hedge funds. These funds provide diversification and reduce portfolio volatility.