Different Types of Mutual Funds
There are various different types of mutual funds present in the market, some of them include balanced funds where the money is invested in mix of the equity and the bonds with fixed income, equity funds where the money is invested only in the stocks of the different companies, fixed-income funds where the money is invested only in the investment that provides fixed amount of return, Index funds where the money is invested in the stocks which correspond with the major market index, Money Market Funds where the money is invested in the short term risk-free securities, funds of funds where the money is invested in the other funds, Global Funds where the money is invested in the instruments which are located outside of the home country and Specialty Funds where the money is invested in the specialized mandates.
A mutual fund is nothing but a financial product that invests in bonds or stocks or both. The pool of money for investments is accumulated by the investors and is managed by portfolio managers. Owning units of a Mutual fund is like owning a small slice of your favorite stock like Alphabet (Google) or Facebook. Investors get mutual fund units in the proportion of their investments.
#1 – Active vs. Passive Funds
The first classification of types of mutual funds is done on the basis of whether the fund is active or passive. Both the investment approaches differ in how the manager wants to invest money and generate returns for account holders. Active funds seek to outperform a specific benchmark it has set for itself, such as the S&P 500 or BSE Sensex. To achieve this, active funds buy and sell stocks, and managers pay attention to factors like economy, political situations, and other trends. He also does research around stock-specific factors like ratio analysis, earnings growth, cash flow available to shareholders and future financial projections, etc.
Passive funds, on the other hand, try to mimic the holdings of a particular index to create similar returns. The manager buys index stocks and applies the same weighting. The objective here is not to beat the index but to remain closer to it. Since index funds require less research and other operational activitiesOperational ActivitiesOperating activities generate the majority of the company's cash flows since they are directly linked to the company's core business activities such as sales, distribution, and production., the cost of buying it is less than an active fund.
In the United States, Vanguard, Blackrock, etc. primarily offer only passive funds like Index fundsIndex FundsIndex Funds are passive funds that pool investments into selected securities. and ETF’s. On the other hand, Fidelity, T Rowe Price, etc. offer many suits of active funds.
In the last five years, passive funds saw a lot of inflows, and their assets under management increased many folds on account of lower fees and better performance than active funds.
#2 – Equity Fund
Equity Funds is a type of mutual fund invests in common stocks of companies listed on the stock market. The primary investment objective of this class of funds is long-term capital growth. Equities are at high risk, high reward asset classAsset ClassAssets are classified into various classes based on their type, purpose, or the basis of return or markets. Fixed assets, equity (equity investments, equity-linked savings schemes), real estate, commodities (gold, silver, bronze), cash and cash equivalents, derivatives (equity, bonds, debt), and alternative investments such as hedge funds and bitcoins are examples.. They can be best suited to people with high risk-taking ability and looking for higher returns.
There are multiple types of equity funds being offered
- Sector funds– Most risky of the lot, these funds invest in a particular sector in the economy e.g., IT sector funds will invest in technology companies only.
- Region or Country funds– The manager invests money in a particular region such as Asia, Latin America, or Europe or in a specific country like the United States, India, or China. This is a slightly lower risk fund than sector fund.
- Large, Mid & Small Cap funds– Investment objective is to invest in particular market capitalization companies such as large-cap funds will invest in blue chip stocksBlue Chip StocksBlue-chip stocks refer to the stock of large stable companies having market capitalization in billions that provide a good return on stocks, may provide dividends, have less risk and are considered to be safe investments. Examples of such stocks include Coca-Cola ltd, IBM Corp, Boeing Co., PepsiCo, General Electric (GE), Intel, Visa, Wal-Mart, IBM Corp, Apple, Walt Disney, Mc Donald’s, Goldman Sachs, Johnson & Johnson, etc. only, while the small-cap fund will invest in stocks with say less than $1 billion market cap. The riskiness decreases with an increase in market cap.
- Diversified Funds– Less risky as investment spread across sectors, regions, countries, and market caps. The manager of this fund requires more skills and knowledge than any other above mentioned types. So selecting the right fund could be challenging. I will try to explain it to readers in the “how to choose a Mutual fund” section.
#3 – Fixed Income Funds (FI)
This type of mutual fund is a bond or debt fund that are a less risky option of investing than in equity fund. The primary objective is to provide steady cash flow to investors. Investment happens in government and corporate debt securities.
source: T. Rowe
These are more suitable for people with risk aversionRisk AversionThe term "risk-averse" refers to a person's unwillingness to take risks. Investors who prefer a low-return investment with known risks to a higher-return investment with unknown risks, for example, are risk-averse. or reaching their retirement age etc.
- High Yield funds– Carries the highest risk of FI funds due to their investment in junk bonds. Junk bonds are lowest-rated bonds (BB or below) by credit rating agencies such as S&P or Moody’s. It provides attractive returns than most other fund types in this group.
- Corporate Bond funds– Companies borrow money at a fixed interest/coupon rate. The mutual fund manager invests in these securities and receives steady cash payments.
- Government Bond Funds or Gilts– Lower risk fund in this group. Invests in government securities like treasury bonds, notes or gilts, etc.
- Money Market Fund- Lowest risk funds that invest mostly in T-billsT-billsTreasury Bills (T-Bills) are investment vehicles that allow investors to lend money to the government.. A return will be less than other types of FI funds, but the risk of losing the money is also negligible.
#4 – Balanced Funds
These types of mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etc are known as hybrid funds. The portfolio holds both equity and debt securities. The primary objective is to gain a capital appreciationCapital AppreciationCapital appreciation refers to an increase in the market value of assets relative to their purchase price over a specified time period. Stocks, land, buildings, fixed assets, and other types of owned property are examples of assets. and generate income for investors. A typical balanced fund invests 60% in equity and 40% in fixed income.
#5 – Alternative Funds
These types of mutual funds are a non-conventional investment vehicle, unlike stocks and bonds. High net worth and institutional investorsInstitutional InvestorsInstitutional investors are entities that pool money from a variety of investors and individuals to create a large sum that is then handed to investment managers who invest it in a variety of assets, shares, and securities. Banks, NBFCs, mutual funds, pension funds, and hedge funds are all examples. are predominantly using this MF type. Due to its complex nature, individual investors are not advised to sign-up for these funds. Alternative Investments funds invest in real estate, commodities, derivatives and futures contracts, and also in hedge funds.
This is a guide to Top 5 types of Mutual Funds – Active Passive Mutual Funds, Index Funds, Balanced Funds, Fixed Income Funds, Alternate Funds, Equity Funds. You may also learn more about Mutual Funds from the articles below –