Equity fund

These funds invest a maximum part of their corpus into equities holdings. The structure of the fund may vary different for different schemes and the fund manager’s outlook on different stocks. Equity funds are considered to be the more risky funds as compared to other fund types, but they also provide higher returns than other funds. It is advisable that an investor looking to invest in an equity fund should invest for long term i.e. for 3 years or more. There are different types of equity funds each falling into different risk bracket. In the order of decreasing risk level, there are following types of equity funds:

Aggressive Growth Funds - In Aggressive Growth Funds, fund managers aspire for maximum capital appreciation and invest in less researched shares of speculative nature. Because of these speculative investments Aggressive Growth Funds become more volatile and thus, are prone to higher risk than other equity funds.

Growth Funds - Growth Funds also invest for capital appreciation (with time horizon of 3 to 5 years) but they are different from Aggressive Growth Funds in the sense that they invest in companies that are expected to outperform the market in the future. Without entirely to post above average earnings in the future.

Specialty Funds - Specialty Funds have stated criteria for investments and their portfolio comprises of only those companies that meet their criteria. Criteria for some specialty funds could be to invest/not to invest in particular regions/companies. Specialty funds are concentrated and thus, are comparatively riskier than diversified funds.. There are following types of specialty funds:

Sector Funds: Equity funds that invest in a particular sector/industry of the market are known as Sector Funds. The exposure of these funds is limited to a particular sector (say Information Technology, Auto, Banking, Pharmaceuticals or Fast Moving Consumer Goods) which is why they are more risky than equity funds that invest in multiple sectors. Regular equity funds invest in a mix of equities that are spread across different sectors.  Therefore they are often referred to as diversified equity funds.

Sector funds, on the other hand, are expected to invest in only a specific sector.  For instance, an energy fund would only invest in energy companies.  Thus, an investor who is bullish about energy and wants an upside that is linked entirely to this sector (without a dilution arising out of exposure to other sectors) would invest in such a fund.

As per the ‘Standard Observations’ (explained in Chapter 8), at least 65 per cent of the investible moneys of any fund need to be invested in the concerned sector / type of security.

In India, on account of a mix of legal slackness, fund managers’ lack of guts and investors’ lack of understanding of the concept, we have a situation where sector funds have ended up becoming diversified equity funds with a bias towards the identified sector!  Unfortunately, we have also seen diversified equity funds managed as if they were sector funds.

Foreign Securities Funds: Foreign Securities Equity Funds have the option  to invest in one or more foreign companies. Foreign securities funds achieve international diversification and hence they are less risky than sector funds. However, foreign securities funds are exposed to foreign exchange rate risk and country risk.

Mid-Cap or Small-Cap Funds: Funds that invest in companies having lower market capitalization than large capitalization companies are called Mid-Cap or Small-Cap Funds. Market capitalization of Mid-Cap companies is less than that of big, blue chip companies (less than Rs. 2500 crore but more than Rs. 500 crore) and Small-Cap companies have market capitalization of less than Rs. 500 crore. Market Capitalization of a company can be calculated by multiplying the market price of the company's share by the total number of its outstanding shares in the market. The shares of Mid-Cap or Small-Cap Companies are not as liquid as of Large-Cap Companies which gives rise to volatility in share prices of these companies and consequently, investment gets risky.

Option Income Funds: While not yet available in India, Option Income Funds write options on a large fraction of their portfolio. Proper use of options can help to reduce volatility, which is otherwise considered as a risky instrument. These funds invest in big, high dividend yielding companies, and then sell options against their stock positions, which generate stable income for investors. A typical option income fund will earn option premium through writing options on securities where the holding income is attractive enough to retain the security as a dead asset.  The underlying view of the fund is that holding income plus option premium more than covers for the opportunity loss. Option Income funds are permitted in India, though none has been launched so far.

Diversified Equity Funds - Except for a small portion of investment in liquid money market, diversified equity funds invest mainly in equities without any concentration on a particular sector(s). These funds are well diversified and reduce sector-specific or company-specific risk. However, like all other funds diversified equity funds too are exposed to equity market risk. One prominent type of diversified equity fund in India is Equity Linked Savings Schemes (ELSS). As per the mandate, a minimum of 90% of investments by ELSS should be in equities at all times. ELSS investors are eligible to claim deduction from taxable income (up to Rs 1 lakh) at the time of filing the income tax return. ELSS usually has a lock-in period and in case of any redemption by the investor before the expiry of the lock-in period makes him liable to pay income tax on such income(s) for which he may have received any tax exemption(s) in the past.

Equity Index Funds - Equity Index Funds have the objective to match the performance of a specific stock market index. The portfolio of these funds comprises of the same companies that form the index and is constituted in the same proportion as the index. Equity index funds that follow broad indices (like S&P CNX Nifty, Sensex) are less risky than equity index funds that follow narrow sectoral indices (like BSEBANKEX or CNX Bank Index etc). Narrow indices are less diversified and therefore, are more risky.

Index funds seek to have a position that replicates an identified index, say, BSE Sensex or NSE Nifty.  Such a position can be created through either of 2 methods -

• It can be done by maintaining an investment portfolio that replicates the composition of the chosen index. Thus, the stocks in such a fund’s portfolio would be the same as are used in calculating the index.  The proportion of each stock in the portfolio too would be the same as the weight of the stock in the calculation of that index.  This replicating style of investment is called passive investment.   Index funds are therefore often called passive funds.  Funds that are not passive are managed funds.Index schemes are also referred to as unmanaged schemes (since they are passive) or tracker schemes (since they seek to track a specific index).Passive investment places lower demands on the time and efforts of the AMC.  All that is required is a good system that would integrate the valuation of securities (from the market) and information of sales and re-purchases of units (from the registrar) and generate the requisite buy / sell orders. Therefore, management fees for index funds are lower than for managed schemes.
• Alternately, a MF, through its research can identify a basket of securities and / or derivatives whose movement is similar to that of the index.  Schemes that invest in such baskets can be viewed as active index funds.Internationally, MFs have proprietary models that help create baskets that seek to outperform the market during a boom, while falling lesser in a bearish market.

Value Funds - Value Funds invest in those companies that have sound fundamentals and whose share prices are currently under-valued. The portfolio of these funds comprises of shares that are trading at a low Price to Earning Ratio (Market Price per Share / Earning per Share) and a low Market to Book Value (Fundamental Value) Ratio. Value Funds may select companies from diversified sectors and are exposed to lower risk level as compared to growth funds or specialty funds. Value stocks are generally from cyclical industries (such as cement, steel, sugar etc.) which make them volatile in the short-term. Therefore, it is advisable to invest in Value funds with a long-term time horizon as risk in the long term, to a large extent, is reduced.

Equity Income or Dividend Yield Funds - The objective of Equity Income or Dividend Yield Equity Funds is to generate high recurring income and steady capital appreciation for investors by investing in those companies which issue high dividends (such as Power or Utility companies whose share prices fluctuate comparatively lesser than other companies' share prices). Equity Income or Dividend Yield Equity Funds are generally exposed to the lowest risk level as compared to other equity funds.