Liquid Funds, as the name suggests, invest predominantly in highly liquid money market instruments and debt securities of very short tenure and hence provide high liquidity.
They invest in very short-term instruments such as Treasury Bills (T-bills), Commercial Paper (CP), Certificates Of Deposit (CD) and Collateralized Lending & Borrowing Obligations (CBLO) that have residual maturities of up to 91 days to generate optimal returns while maintaining safety and high liquidity. Redemption requests in these Liquid funds are processed within one working (T+1) day.
The aim of the fund manager of a Liquid Fund is to invest only into liquid investments with good credit rating with very low possibility of a default. The returns typically take the back seat as protection of capital remains of utmost importance. Control over expenses in the form of low expense ratio, good overall credit quality of the portfolio and a disciplined approach to investing are some of the key ingredients of a good liquid fund.
Most retail customers prefer to keep their surplus cash in Savings Bank deposits as they consider the same to be safest and they could withdraw the money at any time. Liquid Funds and Money Market Mutual Funds provide a more attractive option. Surplus cash invested in money market mutual funds earns higher post-tax returns with a reasonable degree of safety of the principal invested and liquidity.
Liquid funds are preferred by investors to park their money for short periods of time typically 1 day to 3 months. Wealth managers suggest liquid funds as an ideal parking ground when you have a sudden influx of cash, which could be a huge bonus, sale of real estate and so on and you are undecided about where to deploy that money.
Investors looking out for opportunities in equities and long-term fixed income instruments can also park their money in the liquid funds in the meantime. Many equity investors use liquid funds to stagger their investments into equity mutual funds using the Systematic Transfer Plan (STP), as they believe this method could yield higher returns.
Liquid Funds typically do not charge any exit loads. Investors are offered growth and dividend options. Within dividend option, investors can choose daily, weekly or monthly dividends depending on their investment horizon and investment amount. Redemption payment is typically made within one working day of placing the redemption request. With mutual funds going online, individual investors with small sums can look at Liquid funds as an effective short-term investment option over their savings bank account.
An equity fund is a mutual fund scheme that invests primarily in equity stocks.
In the Indian context, as per current SEBI Mutual Fund Regulations, an equity mutual fund scheme must invest at least 65% ( more than 65%) of the scheme’s assets in equities and equity related instruments.
Equity mutual funds are principally categorized according to company size, the investment style of the holdings in the portfolio and geography.
The size of an equity fund is determined by a market capitalization, while the investment style, reflected in the fund's stock holdings, is also used to categorize equity mutual funds.
Equity funds are also categorized by whether they are domestic (investing in stocks of only Indian companies) or international (investing in stocks of overseas companies). These can be broad market, regional or single-country funds. Some specialty equity funds target business sectors, such as health care, commodities and real estate and are known as Sectoral Funds.
IDEAL INVESTMENT VEHICLE
In many ways, equity funds are ideal investment vehicles for investors that are not as well-versed in financial investing or do not possess a large amount of capital with which to invest. Equity funds are practical investments for most people.
The attributes that make equity funds most suitable for small individual investors are the reduction of risk resulting from a fund's portfolio diversification and the relatively small amount of capital required to acquire shares of an equity fund. A large amount of investment capital would be required for an individual investor to achieve a similar degree of risk reduction through diversification of a portfolio of direct stock holdings. Pooling small investors' capital allows an equity fund to diversify effectively without burdening each investor with large capital requirements. The price of the equity fund is based on the fund's net asset value (NAV) less its liabilities. A more diversified fund means that there is less negative effect of an individual stock's adverse price movement on the overall portfolio and on the share price of the equity fund.
Equity funds are managed by experienced professional portfolio managers, and their past performance is a matter of public record. Transparency and reporting requirements for equity funds are heavily regulated by the federal government.
A FUND FOR EVERYONE
Equity funds are very popular amongst the retail investors among various categories of mutual fund products. Whether it’s a particular market sector (technology, financial, pharmaceutical, banking, transportation), a specific stock exchange (such as the BSE or NSE), foreign or domestic markets, income or growth stocks, high or low risk, or a specific interest group (political, religious, brand), there are equity funds of every type and characteristic available to match every risk profile and investment objective that investors may have.
WHAT ARE DIFFERENT CATEGORIES OF EQUITY FUNDS
There are different types of equity mutual fund schemes and each offers a different type of underlying portfolio that have different levels of market risk.
Large Cap Equity Funds invest a large portion of their corpus in companies with large market capitalization are called large-cap funds. This type of fund is known to offer stability and sustainable returns, over a period of time.
Large Cap companies are generally very stable and dominate their industry. Large-cap stocks tend to hold up better in recessions, but they also tend to underperform small-cap stocks when the economy emerges from a recession. Large-cap tend to be less volatile than mid-cap and small-cap stocks and are therefore considered less risky.
Mid-Cap Equity Funds invest in stocks of mid-size companies, which are still considered developing companies. Mid-cap stocks tend to be riskier than large-cap stocks but less risky than small-cap stocks. Mid-cap stocks, however, tend to offer more growth potential than large-cap stocks.
Small Cap Funds Invest in stocks of smaller-sized companies. Small cap is a term used to classify companies with a relatively small market capitalization. However, the definition of small cap can vary among market intermediaries, but it is generally regarded as a company with a market capitalization of less than ₹ 100 crores. Many small caps are young companies with significant growth potential. However, the risk of failure is greater with small-cap stocks than with large-cap and mid-cap stocks. As a result, small-cap stocks tend to be the more volatile (and therefore riskier) than large-cap and mid-cap stocks. Historically, small-cap stocks have typically underperformed large-cap stocks during recessions but have outperformed large-cap stocks as the economy has emerged from recessions.
The smallest stocks of the small caps are called micro-cap stocks. While the opportunity for these companies to experience extreme growth is great, the risk to lose a large amount of money is also possible.
Multi Cap Equity Funds or Diversified Equity Funds invests in stocks of companies across the stock market regardless of size and sector. These funds provide the benefit of diversification by investing in companies spread across sectors and market capitalisation. They are generally meant for investors who seek exposure across the market and do not want to be restricted to any particular sector. They invest in companies across different market caps and hence reduce the amount of risk in the fund. Diversification helps prevent events that could affect a single sector for affecting the fund, and hence reduce risk.
Thematic Equity Funds or Sectorial funds These funds invest in securities of specific sectors such as Information Technology, Banking, Service and pharma sector etc., which is specified in their scheme information documents. So, the performance of these schemes depends on the performance of the respective sector. These funds may give higher returns, but they also come with increased risks.
Equity-Linked Savings Scheme (ELSS) is an equity mutual fund investment that invests at least 80 per cent of its assets in equity and equity-related instruments. ELSS can be open-ended or close ended. Investments in an ELSS qualify for tax deductions under Section 80C of the Income Tax Act within the overall limit of ₹1.5 lakh. The amount you invest in ELSS is deducted from your taxable income, which helps you lower the amount of income tax you are liable to pay. Investments in ELSS are subject to a 3 year lock-in period and the returns from the scheme, i.e. dividends and capital gains, are tax-free.
Market capitalization (commonly known as market cap) is calculated by multiplying a company’s outstanding shares by its stock price per share. A company’s stock price by itself does not tell much about the total value or size of a company; a company whose stock price is say 500 is not necessarily worth more than a company whose stock price is say, 250. For example, a company with a stock price of 500 and 10 million shares outstanding (a market cap of 5 billion) is actually smaller in size than a company with a stock price of 250 and 50 million shares outstanding (a market cap of 12.5 billion).
Investing in equity mutual funds comes at slightly higher risk as compared to debt mutual funds, but they also give your money a chance to earn higher returns. Now that you know more about different types of equity mutual funds, what are you waiting for? Contact us.
A ‘Fund Of Funds’ (FOF) is an investment strategy of holding a portfolio of other investment funds rather than investing directly in stocks, bonds or other securities. An FOF Scheme of a primarily invests in the units of another Mutual Fund scheme.
This type of investing is often referred to as multi-manager investment.These schemes offer the investor an opportunity to diversify risk by spreading investments across multiple funds. The underlying investments for a FoF are the units of other mutual fund schemes either from the same mutual fund or other mutual fund houses.
Experts believe fund of funds are generally better suited for smaller investors that want to gain access to a range of different asset classes or for those whose advisers do not have the expertise to make single manager recommendations.
Under current Income Tax regime in India, a FOF is treated as a non-Equity fund and consequently taxed accordingly. In other words, even though a FOF may be investing in equity oriented funds, the FOF itself is not regarded as an equity oriented fund, and consequently, the tax benefits currently available to an equity fund are not available to an FOF.
Consequently, in case of FOFs investing in equity securities of domestic companies via EOFs, there is dual levy of Dividend Distribution Tax (DDT), viz., when the domestic companies distribute dividends to their shareholders and again, when the FOF distributes the dividends to its unit-holders
If You Want To Avoid The Market Fluctuations Of Equity STOCKS AND ARE RISK-AVERSE, CONSIDER INVESTING IN DEBT-ORIENTED MUTUAL FUND SCHEMES.
A debt fund is a mutual fund scheme that invests in fixed income instruments, such as Corporate Bonds and Government Bonds, corporate debt securities, and money market instruments etc. that offer capital appreciation. Debt funds are also referred to as Income Funds or Bond Funds.
WHO SHOULD INVEST IN A DEBT FUND?
Debt funds are ideal for investors who want regular income, but are risk-averse. Debt funds are less volatile and, hence, are less risky than equity funds. If you have been saving in traditional fixed income products like Term Deposits, and looking for steady returns with low volatility, debt mutual funds could be a better option, as they help you achieve your financial goals in a more tax efficient manner and therefore earn better returns.
HOW DEBT FUNDS WORK?
Debt funds invest in either listed or unlisted debt instruments, such as Corporate bonds and Government Bonds at a certain price and later sell them at a margin. The difference between the cost and sale price accounts for the appreciation or depreciation in the fund’s net asset value (NAV). Debt funds also receive periodic interest from the underlying debt instruments in which they invest. In terms of return, debt funds that earn regular interest from the fixed income instruments during the fund’s tenure are similar to bank fixed deposits that earn interest. This interest income gets added to a debt fund on a daily basis. If the interest payment is received, say, once every year, it is divided by 365 and the debt fund’s NAV goes up daily by this small amount. Thus, a debt scheme’s NAV also depends on the interest rates of its underlying assets and also on any upgrade or downgrade in the credit rating of its holdings.
Market prices of debt securities change with movements in interest rates. Let’s assume, your debt fund owns a security that yields 10 % interest. If the interest rate in the economy falls, new instruments issued in the market would offer this lower rate. To match this lower rate, there would be an increase in the prices your fund’s underlying instruments as they have a higher coupon (interest) rate. As a result of the increase in the debt instrument’s value, your fund’s NAV, too, would increase.
HOW DEBT FUNDS ARE DIFFERENT FROM OTHER MUTUAL FUND SCHEMES?
In terms of operation, debt funds are not entirely different from other mutual fund schemes. However, in terms of safety, they score higher than equity mutual funds. For instance, when the market falls, the NAVs of your equity funds fall sharply, whereas in case of debt funds, the fall is not as sharp. Having said that, debt funds can offer only moderate returns, while equity funds, which are highly risky, offer high returns over longer time horizon.
WHY INVEST IN DEBT MUTUAL FUNDS?
A few major advantages of investing in debt funds are low cost structure, stable returns, high liquidity and reasonablesafety. Debt funds also score on post-tax return. Dividends from debt funds are exempt from tax in the hands of investors.The mutual fund, however, has to pay a Dividend Distribution Tax, which is currently 28.325 per cent in case of individuals or Hindu undivided families. While long-term capital gains from debt funds are taxed at 10 per cent without indexation and 20 per cent with indexation, short-term capital gains taxes are levied according to the income-tax bracket one belongs to.
Thus, debt funds can be a good alternative to investors for achieving their financial goals if they do not intend to bear risk involved in equity investments.
Growth Option vs. Dividend Option
As mentioned above, dividend from mutual funds is tax free in the hands of the investors, but the same is subject to Dividend Distribution Tax (currently 28.325 %), which indirectly decreases the net returns. Hence, dividend payment or dividend reinvestment option gives better post-tax returns, to those who are in the highest tax bracket. However, for those in lower tax slabs, growth option could be more tax-efficient. In short, one should choose the appropriate option depending on the tax bracket.
WHO SHOULD INVEST IN DEBT MUTUAL FUNDS?
There’s no fixed rule as to who should invest in debt funds. It depends on the requirement of investors. Different types of investors invest in different types of debt funds. For instance, if someone wants to park his emergency funds, he can go for liquid funds.
As a thumb rule, 3-6 month’s household expenses can be one’s emergency fund depending on the age. Roughly the amount that gives you the confidence to combat emergencies in your household should be enough. Anything more can actually affect your investment portfolio.
Those in their 20s and 30s might need more, so garner funds for about six months’ expenses, whereas those nearing retirement might not need much as they would have built up their reserves. The amount you save for an emergency depends ultimately on what makes you comfortable.
If you are the risk-averse type, then you might prefer a large fund of, say, a year’s salary. If, however, you are the living on-the-edge type, then six months’ salary might suffice.
For those planning to buy a home after 2-3 years, investing in a combination of both long- and short-term debt funds might be a good idea. Also, a debt fund can be used in the overall portfolio for diversification across asset classes. Debt Funds can also be used for portfolio de-risking when you are nearing your financial goals.
HOW TO PICK THE RIGHT DEBT FUND?
Remember, it is the asset allocation (government securities, corporate debt and marketable securities) that largely determines how a debt fund’s NAV will move. A close look at a fund’s portfolio composition will give you an idea of the expected returns, risks and liquidity. So, when picking a fund, watch out for a few things.
One, check the average maturity of the fund’s portfolio as this has a bearing on your returns. The lower the average maturity period, the lower the fund’s volatility and your returns. On the other hand, a fund with a long maturity period is likely to be more volatile, but the returns are likely to be better.
Two, make sure the fund’s portfolio is reasonably liquid. A large percentage of corporate debt in the portfolio does not bode well in the short term, as it is relatively less liquid. If the fund faces redemption pressure, it would be forced to sell these securities at a discount, lowering the NAV. Also, be wary of funds that hold a lot of unrated and unlisted debt.
Three, avoid schemes with small corpuses. That’s because funds don’t disclose if there are any investor who owns a substantial chunk of outstanding units. If there are such investors and they decide to redeem their holdings, the fund could be forced to sell holdings below the market rates.
Four, the best tool to capture the interest rate sensitivity of a debt fund is modified duration. It tells you how much the price of a bond would move if interest rates move up or down by 1 per cent. The higher the modified duration, the greater will be the impact of an interest rate change. Mutual funds give you access to all the information in their offer documents and other periodic disclosures for you to make an informed decision. It is then up to you to take the investment decision and sign the form, or channel the money to suit your financial needs.
Also, you should understand how interest rate movements, credit ratings and liquidity affect a debt fund’s performance. Theoretically, if interest rates rise, the NAV of a debt fund should fall. That’s because Bond prices move in the opposite direction as interest rates. A fall in bond prices leads to a decline in a fund’s NAV. The opposite would happen if interest rates fell. Of course, in an imperfect and illiquid market like India, this might not happen to the entire extent. Moreover, if some bonds held by your debt fund are upgraded, their prices would rise, leading to a drop in yields. That would, of course, increase your fund’s NAV. So, one should be prepared for fluctuations in one’s fund’s NAV. Even Gilt Funds (which invest only in government securities) that are advertised as the safest available investments, can witness sharp fluctuations in their NAVs. That’s because prices of government securities are a function of various economic factors, including interest rates, macroeconomic data and liquidity in the banking system. When these change, so do the Gilt Fund’s NAV.
WHAT IS AVERAGE MATURITY AND HOW IS IT USEFUL?
Debt funds invest in a number of debt instruments, all of them having a varying maturity. That’s where the average maturity comes handy. As the name suggests, it basically indicates the average maturity of all the securities in a portfolio, giving you the freedom to compare.
Average maturity thus gives you a quick glimpse into the sensitivity of the bond to interest rates. Funds with higher average maturities tend to be more volatile in the short term since their objective is to deliver higher returns over the long term. Simply put, a fund with an average maturity of 5 years is definitely more volatile in the short term than a fund with an average maturity of say 9 months. That’s because in the shorter term there is reasonable surety on the receipt of the coupon income.
So matching your investment horizon with the average maturity is always a good idea. But remember, an average maturity of say 4 years doesn’t necessarily mean that you have to hold it for 4 years. But it definitely indicates is that you can expect to get optimal returns, given the interest rate environment, over 4 years.
Exit load effective mechanism that prompts investors to stay invested through the desired holding period. This ensures that investors, who move in and out of the fund and take away accrued gains during momentary positive market movements, do not short-change diligent investors who stay invested for the entire course.
WHY IS IT ESSENTIAL TO MATCH THE INVESTMENT HORIZON WITH THAT OF THE SCHEME?
Funds having a lower average maturity are ideal for short-term holdings as they are well protected from the fluctuating interest rate movements. However, holding them for more than their average maturity may not get you the optimal results.There can be various types of debt funds based on the average maturity of the instruments invested in. Although debt funds are less risky than equity funds, they are still subject to market volatility.The level of volatility therefore depends on the average maturity of the specific portfolio.
The higher the average maturity, the greater the uncertainty in the short term, which is what results in greater volatility. Conversely, the lower the average maturity, the greater the certainty, which in turn lowers volatility.
Liquid funds are the least volatile as their maturity is in days and at the other extreme there are income funds, where the average maturity is in multiple of years.
So in order to really get the most out of debt funds, it is essential that you match your investment horizon with the average maturity of the scheme.
USING DEBT FUNDS FOR STP AND SWP
Debt funds also allow you to take advantage of investing in equity market along with growth on your principal amount through Systematic Transfer Plan (STP). With an STP, you can transfer amounts in parts/tranches from one mutual fund scheme to another, within the same fund house at regular intervals. Such a transfer averages the cost of purchase,mitigating some market-related risks. Typically, an investor first parks his funds in a liquid or a floating-rate debt fund and then transfers them via STP to the scheme (usually equity or balanced) of his choice at regular intervals.Also STP work in equity fund to debt fund too.
Systematic withdrawal plan (SWP) is a payment option in a mutual fund that lets you redeem units worth a pre-specified amount at a specific intervals (monthly, quarterly, half-yearly or annually). This is suitable for the investors who desire periodic or regular income.
A balanced fund combines equity stock component, a bond component and sometimes a money market component in a single portfolio. Generally, these hybrid funds stick to a relatively fixed mix of stocks and bonds that reflects either a moderate, or higher equity, component, or conservative, or higher fixed-income, component orientation.
These funds invest in a mix of equities and debt, giving the investor the best of both worlds. Balanced funds gain from a healthy dose of equities but the debt portion fortifies them against any downturn.
Balanced funds are suitable for a medium-term horizon and are ideal for investors who are looking for a mixture of safety, income and modest capital appreciation. The amounts this type of mutual fund invests into each asset class usually must remain within a set minimum and maximum.
Although they are in the "asset allocation" family, balanced fund portfolios do not materially change their asset mix. This is unlike life-cycle, target-date and actively managed asset-allocation funds, which make changes in response to an investor's changing risk-return appetite and age or overall investment market conditions.
EQUITIES AND INFLATION
Investors who have dual investment objectives favour Balanced Funds. Typically, retired person or investors with low risk tolerance prefer these funds for growth that outpaces inflation and income that supplements current needs. While retired person generally scale back risk as age advances, many individuals recognize the need for equity exposure as life expectancies increase. Equities prevent erosion of purchasing power and help ensure long-term preservation of retirement corpus
The bond component of a balanced fund serves two purposes: creating an income stream and moderating portfolio volatility. Investment-grade bonds such as AAA corporate bonds and Money market instruments interest income from periodic payments, while large-company stocks offer dividend pay-outs to enhance yield. Retired investors may take distributions in cash to bolster income from pensions and personal savings.
Secondarily, bonds hold much less volatility than stocks. Bondholders have a claim against assets of a company while stocks represent ownership, bearing all inherent risk if bankruptcy occurs. Hence, debt security prices do not move in lockstep with equities, and their stability prevents wild swings in the share price of a balanced fund.
© 2017 Aapka Banker. All rights reserved.
Design & Developed by MNS Technologies