Tuesday, April 18, 2017

Types of Mutual Funds

collection of people-investment-bank-shares-bonds

Mutual funds can be categorised based on a few aspects as follows:
  1. Nature of underlying assets: Equity/ Debt funds
  2. End use of income: Growth/ Regular Income
  3. Type of fund management: Active/ Passive
  4. Liquidity: Liquid funds
  5. Exchange Traded Funds

Equity versus Debt funds:

This aspect is based on what type of assets into which the money is invested. There are three possible sub-categories:
  • Invest funds 100% in equity shares of companies
  • Invest funds 100% funds in debt instruments like government bonds, treasury bills, corporate bonds, etc.
  • Hybrid funds where money is partly invested in shares and partly in debt instruments

Growth versus Regular Income Funds:

In a growth fund, the income like dividend received from the underlying assets are reinvested. Growth funds are usually equity based.
On the contrary in a regular income fund the income earned by the fund by way interest, dividend, etc is distributed to the unit holders.
man watering plant for growth and coins paid as income

One obnoxious practice many mutual funds engage in is that they distribute sale proceeds of investment assets (capital receipts and not income receipts) as dividends to unit holders.

Active vs Passively Managed Funds:

Mutual fund managers constantly churn portfolios with an intended objective of beating the performance of certain benchmark indices like S&P 500, BSE Sensex, etc. Such funds are called actively managed funds. The funds charge high fund management fees (3–4%) as a justification for actively managing the funds. This is does not benefit the mutual fund investors.
active fund manager dancing and passive manager dozing

On the contrary, passively managed funds reflect a popular index like S&P 500 and BSE Sensex. In this case the fund manager simply makes an one-time investment in the exact proportion corresponding to the composition of the index, and simply sits quiet. Any changes will be made only when there is a change in the composition of the index. Since the fund is not actively managed the fund management fee is very low (usually below 0.50%). The passive funds are beneficial for the investors as the actively managed funds have any established track record of superior performance over a long period of time.

Liquid Funds:

Liquid funds are meant for companies and corporations which tend to hold huge funds for temporary periods. They would like to invest these funds and earn returns for short periods of time. Such funds are called liquid funds. These funds offer only limited returns and almost negligible growth (capital appreciation). Liquid funds are not meant for common investors who are on the way of building wealth. 
share and bond investments floating in water current

Exchange Traded Funds:

Exchange traded funds (ETFs) are a totally unique concept of a mutual fund. It is doubtful whether an ETF can be discussed in the same breath with a mutual fund at all.
The units of an ETF are listed on the stock exchanges and trade shoulder-to-shoulder with shares. Thus ETFs provide following unique features to an otherwise normal mutual mutual fund:
  1. Convenience - unlike subscription to mutual funds, there is absolutely no paper work involve. One can simply buy and sell them on the stock trading platform.
  2. No special redemption process: If an investor wants to liquidate the investment with a regular mutual fund he or she has to submit an application to the mutual fund for redemption. This may take some time. However in the case of ETFs the investor simply sells on the on-line trading platform and the proceeds.
  3. Exchange Traded Funds mostly track popular indices like the S&P 500 and BSE Sensex, NIFTY 50 and so on and therefore are passively managed with consequent low fund management fees.

Letters "ETF" in Bright Orange Colour inside a tag

Suggested Related/ Further Reading:

In conclusion there are many types of mutual funds based on the assets managed, whether income is accumulated or distributed, whether actively or passively managed, etc.