Mutual funds offer several benefits and are slowly emerging as a preferred investment option. It is also a popular investment scheme among beginners.
The biggest advantage of investing in a mutual fund is that it allows you to choose from a wide range of mutual fund schemes according to your risk appetite and financial goals.
SEBI recognizes five types of fund categories which are:
Debt funds– These funds invest mostly in debt securities.
Equity funds – These funds invest a majority amount in equity and equity-related instruments.
Solution-Oriented funds – These funds are aimed at investing in specific financial goals such as children’s education, retirement planning, etc.
Hybrid Funds – These funds tend to invest in different asset classes according to the objective of the scheme.
Other Schemes – These types of funds include Exchange Traded Funds (ETFs), index funds, Fund of Funds (FoFs), etc.
Why do people invest in mutual funds?
Most people prefer investing in mutual funds because of the following features;
They are professionally managed: Mutual funds are managed by expert fund managers. They do the research and help you select the funds according to your financial goal and risk appetite. Fund managers also monitor performance.
Diversification: Mutual funds allow you to invest in a range of investment schemes across various companies and industries. This helps to lower the risk in case one company fails.
Affordable: Most mutual funds are relatively priced lower not just for the initial investment but subsequent purchases as well.
More liquid: Investors can easily redeem their mutual fund shares at any time at the current Net Asset Value (NAV) and redemption fees.
List of securities in which different types of mutual funds make investments:
1. Equity Shares:
These are the most common investment options for equity funds. It drives a major portion of the Domestic Institutional Investors (DII) into the equity markets.
2. Equity Derivatives:
Derivatives are contracts between two parties. They derive their value from the underlying assets and its value will depend on the movements in the values of underlying indices.
Generally, a part of the mutual fund portfolio is allocated to equity derivatives to hedge investment exposure.
Arbitrage funds use the arbitrage opportunities between derivative and equity markets to generate returns to the investors.
3. Government Securities (G-Secs)
These are debt securities issued by the state and the Central government. These securities are issued by the government to bridge their funding requirements.
Government securities are perceived to be as secure investments. However, G-Secs issued for a longer duration may expose investors to higher interest rate risks. The best examples of G-Secs are gilts funds.
4. Corporate Bonds
Corporate bonds are issued by corporate and banks with guaranteed interest rates. However, the credit risks of such bonds vary according to the credit ratings of the companies. Also, the duration of the bonds determines the sensitivity of the debt securities to the interest rate movements. Examples of funds that invest in corporate bonds are corporate bond funds, duration funds, credit risk funds, banking & PSU funds, etc.
5. Short Term Debt Securities:
These securities are issued for the short term by various entities such as banks, corporate, government and financial institutions. Short term debt securities include Treasury Bills (T-Bills), Certificate of Deposits (CDs), Commercial Papers(CPs) overnight securities, etc.
The interest rate risks of these securities are minimal.
Also, the interest rate is almost negligible for overnight and liquid funds that invest in securities with maturity of 1 day and up to 91 days respectively.
The above-mentioned securities are a list of securities for the mutual funds to invest in. However, the exact proportion of the asset classes and segments (duration of securities, market capitalization, etc) depend on the fund category, the objective of the investment and fund manager’s skills.