16.5 Types of mutual fund schemes

Hanumant Dhokle

A wide variety of mutual fund schemes exist to cater to the needs such as financial position, risk tolerance and return expectations etc. The table below gives an overview of the existing types of schemes in the MF industry.

By structure:

  1. Open-ended schemes
  2. Close-ended schemes
  3. Interval schemes

By investment objective:

  1. Growth schemes
  2. Income schemes
  3. Balanced schemes
  4. Money market schemes

Other schemes:

  1. Tax saving schemes
  2. Special schemes
  3. Index schemes
  4. Sector specific schemes

By Structure

Open-ended Funds:

An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value (“NAV”) related prices. The key feature of open-end schemes is liquidity. Majority of mutual funds are open-ended.

Open funds have no time duration, and can be purchased or redeemed at any time, but not on the stock market. An open fund issues and redeems shares on demand, whenever investors put money into the fund or take it out. Since this happens routinely every day, total assets of the fund grows and shrinks as money flows in and out daily. The more investors buy a fund, the more shares there will be. There’s no limit to the number of shares the fund can issue. Nor is the value of each individual share affected by the number outstanding, because net asset value is determined solely by the change in prices of the stocks or bonds the fund owns, not the size of the fund itself.

What are the advantages of investing in an open-ended fund?

High liquidity coupled with the transparency and freedom to exit acts as a check on the fund managers to ensure good performance. This is the main advantage of investing in mutual fund schemes. Open-ended funds disclose NAV on a daily basis and the portfolio on a quarterly basis. These funds have several conveniently designed saving plans. A systematic investment plan (SIP) offers the convenience of a bank’s recurring deposit account, with the added advantage of “rupee cost averaging”. Many open ended funds presently repurchase quickly from a wide service network. Some liquid funds have now introduced cheque book facility subject to certain conditions.

Risks

One unique risk to open end funds is that they may be subject to inflows at one time or sudden redemptions, which leads to a spurt or a fall in the portfolio value, thus affecting your returns. Also, some funds invest in certain sectors or industries in which the value of the stocks in the portfolio can fluctuate due to various market forces, thus affecting the returns of the fund.

Closed-ended Funds:

A closed-end fund has a stipulated maturity period which generally ranges 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. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices. SEBI regulations stipulate that at least one of the two exit routes is provided to the investor.

What is the difference between an open-ended and a close-ended scheme?

Open-ended funds can issue and redeem units any time during the life of the scheme, while close-ended funds cannot issue new units, except in case of bonus or rights issue. Hence, unit capital of open-ended funds can fluctuate on daily basis, while that is not the case for close-ended schemes.

To simplify further, new investors can join the scheme by directly applying to the mutual fund at applicable NAV-related prices in case of open-ended schemes, while in the case of close-ended schemes, new investors can buy the units from secondary market only. But open-end funds have one negative as compared to close-ended 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.

Interval Funds:

Interval funds combine the features of open-ended and close-ended schemes. They are open for sale or redemption during pre-determined intervals at NAV related prices.

By Investment Objective

Another classification is by investment objective- Such schemes may be open-ended or close-ended as discussed earlier.

Growth Funds:

The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a majority of their corpus in equities and have comparatively high risk. It has been proven that returns from stocks, have outperformed most other kind of investments held over the long term. Growth schemes are ideal for investors having a long-term outlook seeking growth over a period of time.

Good Investment for:

  1. Investors in their prime earning years.
  2. Investors seeking growth over the long term.

Income Funds:

The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures and government securities. Income funds are ideal for capital stability and regular income.

Good Investment for:

  1. Retired people and others with a need for capital stability and regular income.
  2. Investors who need some income to supplement their earnings.

Balanced Funds:

The aim of balanced funds is to provide both growth and regular income. Such schemes periodically distribute a part of their earning and invest both in equities and fixed income securities in the proportion indicated in their offer documents. In a rising stock market, the NAV of these schemes may not normally keep pace, or conversely, they may not fall equally when the market falls. These are ideal for investors looking for a combination of income and moderate growth.

Good Investment for:
Investors looking for a combination of income and moderate growth.

Money Market Funds:

The aim of money market funds is to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money. Returns on these schemes may fluctuate depending upon the interest rates prevailing in the market. These are ideal for corporate and individual investors as a means to park their surplus funds for short periods.

Good Investment for:

Corporates and individual investors as a means to park their surplus funds for short periods or awaiting a more favourable investment alternative.

Other Schemes

Tax Saving Schemes:

These schemes offer tax rebates to the investors under specific provisions of the Indian income tax laws as the government offers tax incentives for investment in specified avenues. Investments made in equity-linked savings schemes (ELSS) and pension schemes are allowed as deduction u/s 80C of the Income Tax Act, 1961. The Act also provides opportunities to investors to save capital gains u/s 54EA and 54EB by investing in mutual funds. The only drawback to ELSS is that you are locked into the scheme for three years.

Good Investment for:

Investors seeking tax incentives.

Special Schemes

Industry-Specific Schemes:

Industry-specific schemes invest only in the industries specified in the offer document. The investment of these funds is limited to specific industries like IT, FMCG, and pharmaceuticals etc.

Index Schemes:

Index funds attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50 (Nifty).

Sectoral Schemes:

Sectoral funds are those which invest exclusively in a specified industry or a group of industries or various segments such as ‘A’ Group shares or initial public offerings.

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