Equity Mutual Funds

What is an Equity Mutual Fund?

It is a mutual fund scheme that invests majorly in stocks or shares of different companies. Equity Mutual Funds are also known as Growth Funds. Such funds can either be active or passive.

In Active Mutual Funds, a fund manager analyses the market well, conducts thorough research on companies, examines their performance, and picks the best stocks to invest in. On the contrary, the fund managers in Passive Mutual Funds develop a portfolio mirroring a popular market index such as Nifty 50 or SENSEX.

Besides, Equity Mutual Funds are also categorised based on market capitalisation, which defines the value of an entire company’s equity in the capital market. Based on the market cap, funds are divided into Small Cap, Mid Cap, Large Cap, and Small or Micro Cap Funds.

Similarly, there are various types of equity funds. Read further and find the best Equity Mutual Funds offered by various sellers.

Types of Equity Funds

The mutual fund market is soaked in a diverse range of Equity Mutual Funds. However, not every fund would be a right fit. The scheme you choose must depend on your investment goal, investment horizon and risk profile. The following are the categories of Equity Mutual Funds:

Based on Investment Strategy

There are primarily three types of Equity Mutual Funds based on investment strategy. They are as follows:

Thematic or Sectoral Funds: As per the mandate issued by SEBI (Securities and Exchange Board of India), Thematic/Sectoral funds must invest at least 80% of their assets in a specific theme or sector.

Sectoral Funds park their fund in one specific sector, such as technology, banking, infrastructure, FMCG, pharmaceuticals, etc. On the other hand, Thematic Funds cover multiple sectors.

For instance, the consumption theme can encompass automobiles, banking and financial services, consumer non-durables, consumer durables, entertainment and media, etc. Likewise, healthcare themes can include various sectors, including pharmaceuticals, e.g. wellness products, diagnostic centres, hospitals, health insurance, etc.

Thematic funds are comparatively more diversified than Sectoral Funds. However, both funds are highly risky compared to diversified equity funds.

Focused Equity Funds: According to SEBI’s mandate, these funds can’t invest in more than 30 stocks. Since the number of stocks is restricted to 30, the concentration risks are comparatively higher than more diversified equity funds. If the fund manager manages to invest in the right stocks, these funds are highly capable of delivering impressive returns.

Contra Funds: These types of funds mainly invest in equities of companies that aren’t doing well in short. The notion behind such investments is to purchase equities at a low price today. When the business issues are resolved, these stocks may witness a strong rally and prove profitable in the long term.

Based on Market Capitalisation

Every equity fund is subject to huge market risks. However, the risk profile of every security differs based on their categorisation. Market capitalisation is one of the major risk characteristics of equity securities, depending on the company’s size.

Based on the market capitalisation, Equity Funds are classified into the following types:

Small Cap Funds

Such funds can invest their minimum asset of 65$ in equity shares of companies with a small market capitalisation (251 and more companies). While Small Cap Funds possess the potential to deliver great returns than Mid Cap and Large Cap Funds, they are also comparatively more volatile.

Large Cap Funds

Such Equity Funds put at least 80% of their corpus in equity shares of companies with a large market capitalisation (top 100 companies). Large Cap Funds invest in stocks/companies that are well-established and have a proven track record. Such funds have the potential to deliver more impressive returns than Small Cap and Mid Cap Funds. Relatively, Large Cap Funds are less volatile.

Large and Mid Cap Funds

As the name suggests, these funds invest in large and mid-cap companies. Assets of at least 35% of Large and Mid Cap funds go into both large-cap (top 100 companies based on their market capitalisation), and the same percentage is invested in mid-cap companies (100-250 companies based on their market capitalisation).

However, the remaining 30% of these funds are invested in other money market instruments and securities that SEBI may authorise.

Mid Cap Funds

These funds invest at least 65% of their capital in equity shares of 101 to 250 mid-cap companies whose market capitalisation lies between large and small-cap stocks. Compared to Large Cap Funds, Mid Cap Funds are more volatile and capable of generating better returns.

Multi Cap Funds

True to its name, Multi Cap Funds invest in many companies based on suitable market conditions, including Small Cap, Medium Cap, and Large Cap companies. This allows the investor to invest in a diversified portfolio across market capitalisation.

*As per the circular issued by SEBI on September 11, 2020, Multi Cap Funds must invest at least 25% of their assets in small-cap, 25% in mid-cap, and 25% in large-cap companies.

Based on Tax Benefits/Asset Class

ELSS or Equity-Linked Saving Schemes are the best equity mutual funds for those who want to save tax on their investments. ELSS equity funds are known as ‘Tax Saving” funds. As per the Equity Linked Saving Scheme, 2005, and as notified by the Ministry of Finance, at least 80% of the total assets of ELSS go into equity and equity-related securities.

The Scheme allows investors to save up to ₹ 1.5 Lakhs on taxes under the Income Tax Act 1961. The Equity-Linked Saving Scheme has a statutory lock-in period of three years. This, in turn, helps in the reinvestment of returns and eventually ends up yielding higher returns.

Based on Investment Style

There are two types of Equity Funds based on investment style. They are as follows:

Active Funds: In such schemes, fund managers take a hands-on approach, conduct a deeper analysis of different companies, and plan when to pivot into or out of a specific bond, stock, or asset. The prime motive of Active Funds is to beat the stock market's average returns and take complete advantage of short-term price fluctuations.

Passive Funds: Unlike Active Funds, Passive Funds invest in indices of the equity market like SENSEX, Nifty Fifty, etc. and aim at generating maximum returns.

Benefits of Equity Funds

The following are the benefits of investing in equity mutual funds in India:

Portfolio Diversification: Investing in Equity Mutual Funds means your money is distributed across multiple companies. Holding shares and stocks of different companies based on the theme, sector, market capitalisation, or mandate only diversifies your portfolio. Moreover, losses incurred in one segment are easily offset by profits made in the other.

High Degree of Liquidity: While equity mutual funds have less liquidity than saving bank accounts or liquid funds, about 35% of such funds are parked in debt funds, which deliver a liquid element to equity funds. Therefore, equity funds render a moderate amount of liquidity.

Convenience and Ease of Investment: The most significant benefit of investing in such funds is that the investors are free from making investment decisions. Therefore, it saves all the knowledge, research, and time required to find the right stocks. Unlike in the stock market, you are saved from analysing the market trends or projecting the industry's future performance. Therefore, investing in such funds provides you with the highest extent of ease and convenience.

Inflation Beating Returns: As per historical records, equity mutual funds have stayed ahead of inflation at the very least. On the contrary, conservative investment choices such as fixed and recurring deposits render a return rate with almost little value when inflation is factored in.

Professionally Managed Funds: The major part of equity mutual funds are controlled by experienced fund managers in partnership with market connoisseurs. The main work of fund managers involves keeping track of the market at all times and making modifications to the portfolio based on the current trend. This reduces the risk and facilitates investment for you.

Therefore, even if you are a novice or newbie, you can still park your money in equity schemes without acquiring ample knowledge.

Sharp Capital Appreciation: Equity mutual funds offer sharper capital appreciation than other investment alternatives. This feature of equity funds makes these funds an appealing investment route for the long term and indemnifies inflation and market growth.

Who Should Invest in Equity Funds?

Your investment objective, risk profile, and the horizon must sync with your investment in equity funds. Typically, if you aim to invest for the long term (for example, five years or more), you must go for an equity fund. This will also allow you the much-needed time to survive the market volatility.

The following are the entities that must invest in equity mutual funds in India:

For Market Savvy Investors

If you have a knack for investing, are well-versed in market fluctuations, and are prepared to take calculated risks, you may try dipping your feet into diversified equity funds. Such funds park their money in shares of various companies with different market capitalisations. As a result, these funds are more likely to offer an excellent blend of high returns at lower risk compared to funds that only invest in small-cap/mid-caps.

For Budding Investors

If you are a newbie in the investment market who seeks exposure to the stock market, then equity funds could be the best investment choice. Investing in large-cap equity funds will put your money in equity shares of top-performing stocks with lower risk levels. Historical data suggests that well-established companies have often delivered stable and better returns over a long period.

How Do Equity Funds Earn?

While investing in mutual funds, investors usually earn two distinct ways — capital gains and dividends. When they invest funds in stocks, they offer dividends depending on their market earnings. If you prefer to receive these dividends, your earnings or return on investment will be your earnings. Nevertheless, various AMCs (Asset Management Companies) will provide you with a second alternative. Here you can reinvest your money earned as dividends and grow your corpus with the power of compounding.

Another option is to generate wealth through capital gains. It is identical to the share market, where you purchase the units of mutual funds for a specific amount. When the price of the units goes up at some point in the future, you can earn a profit by selling your units.

Things to Consider Before Investing in Equity Funds

Here are a few significant factors that you must ponder upon before putting your money into equity funds.

Fund Objectives: The best equity mutual funds employ a powerful investment strategy to help investors discover their wealth accumulation objectives. Investors can follow certain investment styles, such as growth or value investing, to choose their stocks.

Growth investing primarily emphasises investing in stocks that depict above-average growth, even if the price of the shares or stocks appears to be somewhat expensive. On the other hand, value investing mainly focuses on parking your fund in undervalued stocks whose prices may increase, resulting in a profit.

Cost Analysis: As fund managers manage the equity portfolio of investors, there are some fees associated with fund management, known as the expense ratio. It is the percentage of the investment. Therefore, the smaller the expense ratio, the greater the profit earned.

According to the directive issued by the SEBI, the expense ratio must not be more than 2.5%. Moreover, it must be mentioned that compared to equity index funds, actively-managed equity funds have a higher expense ratio.

Financial End-Goal: Various market jargon recommends investing in the best equity mutual funds for lum-sum investment or SIP (Systematic Investment Plan) if investors seek to satisfy their long-term financial objectives, be it retirement planning or wealth creation. Provided its return profile, investors can create a significant corpus by investing in the best equity mutual funds in India. The returns rendered by equity funds will help you achieve financial stability, allowing you to follow your passion and retire confidently.

Investment Horizon: Equity mutual funds are not for those looking to generate a huge corpus in a shorter span. In the short haul, equity schemes are exposed to volatility, which averages out only after a minimum term of about five years.

Therefore, every investor investing in equity-based mutual funds is advised to keep a long-term horizon.

Fund Types: Equity funds are categorised into small-cap, mid-cap, and large-cap. Mid-cap and large-cup funds have higher risk factors, but they also have the potential to offer higher returns. Large-cap investments may not provide you with impressive returns sooner, but they cut down the investment risks significantly and may offer stellar long-term returns.

Equity mutual funds also invest in multi-cap funds, which put your funds across diverse market caps for an optimally diversified portfolio.

High Volatility: Be it any type of equity fund, all are exposed to certain market risks. Hence, they are prone to fluctuations in the benchmark indices like SENSEX or NIFTY. Any fall or rise of these indices will appear in the value of the equity fund. Therefore, it is more volatile than debt or money market funds.

Equity Mutual Fund Taxation*

If the investor holds the units for less than one year, then the capital gains on such investments are termed STCG (Short Term Capital Gain). STCGs are taxed at 15% provided that the seller pays a Securities Transaction Tax of 0.01%. Equity funds qualify for STCG only if held for less than 12 months.

However, the capital gains in equity mutual funds will be taxed at 10% if capital gains surpass ₹ 1 lakh in a year without any indexation benefit. Such capital gains are referred to as LTCG (Long Term Capital Gains). For the funds to be called LTCG, the investor must hold them for more than 12 months.

Nevertheless, ELSS funds are different from regular equity funds. Since ELSS has a lock-in period of 3 years, they can be redeemed only at the tenure end. Under Section 80C of the Income Tax Act, the ELSS fund has taxation benefits of up to ₹ 1.5 lakhs.