Types of Mutual Funds in India with Examples

Types of Mutual Funds - IMAGE

Is it for real to say that all mutual funds are not same? Are there really different types of mutual funds operating in India? Yes, every mutual fund scheme is unique. What makes it unique? Its portfolio composition.

The philosophy that goes behind building a mutual fund scheme’s portfolio makes it unique. The philosophy will decide which constituents (securities) gets added to the portfolio.

A mutual fund will have different securities in its portfolio. But all of them will have a common theme (based on its philosophy). The common theme makes them similar. This similarity between all securities, within a portfolio, gives it its unique type.

Example:

  • All equity based funds will invest heavily in stocks.
  • All debt based funds will invest predominantly in bonds, money market etc.
  • International funds will invest in international stocks.

Why investors must know the “types of mutual funds”?

Why one invests in mutual funds? There can be several purpose of investment. Few common ones are listed below:

Stocks Analysis Worksheet - Plus - Basket
  • Long Term Goal:
    • Capital Growth.
    • Corpus building etc.
  • Short Term Goal:
    • Capital (Principal) Protection.
    • Income Generation.
    • Emergency Fund Building.
    • Staying sufficiently liquid etc.

Depending on the purpose (goal) of investment, return on investment (ROI) requirement changes. How ROI requirement change?

Example: when purpose is capital growth, high return is expected. When purpose is income generation, low return is expected.

So depending upon the goals (ROI requirement), one needs to take different risks. Why to take risk? Because to earn higher returns, one need to invest in riskier investment options. To earn lower returns, one can invest in less-risky options.

Types of Mutual Funds - Goal Risk Return

What is the point?

Every investment goals has different return expectation. Accordingly, one needs to invest in different type of mutual funds to get the desired results.

When return expectation is low, one need to invest in a different type of mutual fund.

When return expectation is high, a different type of mutual fund will be suitable.

When return expectation is moderate, there are different types of mutual funds to meet this need.

Hence a clear knowledge of different types of mutual fund schemes available for investing, will help the investor in picking the right fund suiting the goal.

Why right mutual fund selection is important for investors?

When requirement is regular income generation, investing in diversified equity mutual fund will be a mistake.

When requirement is capital protection, investing in equity based scheme will be risky.

If one wants to invest for long term capital growth, investing in liquid funds will yield below par results.

What is the point?

Knowledge of the types of mutual funds will help in picking of right funds for different investment goals (needs).

Selection of a wrong type of mutual fund will invariably lead to losses and dissatisfaction.

If this happens, then the whole purpose of investment fails. Hence, selection of right type of mutual fund is of paramount importance.

For a common man, if he/she is able to select the right mutual fund, in accordance with the goal, it is equivalent to 99% job done, in a right way.

What is the balance 1%? Timing the sale of mutual fund units.

But before we proceed and start discussing the types of mutual funds, allow me to introduce you to a concept called “sharpe ratio“. This one tool perfectly works in selection of right type of funds.

Sharpe Ratio

Why I am abruptly bringing the topic of “Sharpe Ratio” here? It is not abrupt. In fact the concept of Sharpe Ratio fits perfectly here.

Sharpe Ratio is a measure of return generated by a mutual fund, per unit risk taken.

The higher is the Sharpe Ratio, the better.

What does it mean? Two considerations first:

  • The higher the returns, the better, right? Yes.
  • The lower the risk, the better, right? Yes.

Suppose there is an index fund (X) which is generating returns of R%. But to generate this high returns it is taking unprecedentedly high risks (Sd1). Such a mutual fund will have a lower Sharpe Ratio.

Sharpe Ratio = Return (R%) / High Risk (Sd1) = Low Sharpe Ratio.

Similarly, there is another index fund (Y) which is generating same returns as X (R%). But to generate this high returns it is taking lower risks (Sd2) [Sd2 is less than Sd1]. Such a mutual fund will have a higher Sharpe Ratio.

Sharpe Ratio = Return (R%) / Lower Risk (Sd2) = Higher Sharpe Ratio.

What we can conclude about X & Y? Both of them are same type of mutual funds, but as Y’s sharpe ratio is more than X’s, then Y will be a better pick.

[I have written a separate article dedicated to Sharpe Ratio. To know more about sharpe ratio, read this article please.]

In this article, how we will use the concept of Sharpe Ratio? For each type of mutual fund, we will state its following two parameters:

  • Return it can generate, and
  • Its sharpe Ratio.

These two parameters will help us to compare different mutual fund. How?

For the same level of returns, the mutual fund type which has higher Sharpe Ratio is better.

Types of Mutual Funds - Sharpe Ratio

IMPORTANT: One cannot compare Sharpe Ratio of Equity based funds with Debt based funds.

Read more about the Sharpe Ratio here…

Types of Mutual Funds in India with Examples

There are several ways to classify mutual funds operating in India. But in this blog post we will classify the mutual funds based on their risk-return balance.

This way of classification is both easy to remember and useful. Why? Because it serves two important purpose:

  • It helps us to pick right mutual funds based on return requirement (goal).
  • It helps us to visualise mutual funds based on their portfolio constituents.

All mutual funds can be broadly classified into four types:

Types of Mutual Funds - Equity Debt Reits Gold

We will discuss equity and debt based funds in detail. REITs funds has still not been launched in India for retail investors. Discussion on Gold funds can be ignored as equity and debt funds provide enough alternatives.

#1. Equity Based Funds

As the name suggests, equity based funds will have a portfolio heavily loaded with equity. But this does not mean that all equity based mutual funds are same.

Equity based funds can be further divided into the following types:

  1. Index Funds.
  2. Diversified Equity (Multi Cap) Funds.
  3. Large Cap Funds.
  4. Mid-Cap Funds.
  5. Small Cap Funds.
  6. Sector Funds.
  7. Equity Linked Savings Scheme (ELSS).

#1.1 Index Funds

They invest only in those companies which are part of a particular index. The share of companies are included in same proportion as their weightage in the index.

Example: Top 3 index funds operating in India based on their returns in last 10 years:

Types of Mutual Funds - Index Funds - Sharpe Ratio2

Note 1: As a reader what is important to note here is the Sharpe Ratio of Index Funds for time horizon of 3 Years, 5 Years, and 10 Years respectively.

Why it is important? This will help us to compare index funds with other types of equity mutual funds. Theory is, higher is the Sharpe Ratio the better.

Note 2: The above table can also be read like this:

  • To generate 11.24% p.a. return in 3 years, index fund’s yields a sharpe Ratio of 0.59.
  • To generate 12.49% p.a. return in 5 years, index fund’s yields a sharpe Ratio of 0.61.
  • To generate 13.44% p.a. return in 10 years, index fund’s yields a sharpe Ratio of 0.56.

Note3: Within time horizons of 3Y, 5Y and 10Y, index funds has yielded best Sharpe Ratio for 5Y periods. Hence we can broadly say that, index funds perform well (return generated per unit risk taken) when held for a 5 years periods.

#1.2 Multi Cap Funds

This type of equity based mutual funds has the maximum range of investment options. They can basically invest in all type of stocks. Neither sector nor the size of companies is a barrier for them.

Example: Top 3 multi cap funds operating in India based on their returns in last 10 years.

Types of Mutual Funds - MultiCap Funds - Sharpe Ratio

Note 1: The above table can be read like this:

  • To generate 9.68% p.a. return in 3 years, multi-cap fund’s yields a sharpe Ratio of 0.51.
  • To generate 15.98% p.a. return in 5 years, multi-cap fund’s yields a sharpe Ratio of 0.82.
  • To generate 16.50% p.a. return in 10 years, multi-cap fund’s yields a sharpe Ratio of 0.71.

Note2: Within time horizons of 3Y, 5Y and 10Y, multi-cap fund’s has yielded best Sharpe Ratio for 5Y periods (0.82). Hence we can broadly say that, multi-cap funds perform well when held for a 5 years periods.

Note3: Comparison between index funds and multi-cap funds in terms of their sharpe ratio:

Sharpe Ratio3Y5Y10Y
Index Funds0.590.610.56
Multi Cap Funds0.510.820.71

For 3Y period, index funds yield higher sharpe ratio. For 5Y and 10Y periods, Multi-Cap funds yields higher sharpe ratio.

#1.3 Large Cap Funds

These mutual funds invests mainly in Large, Blue chip stocks. The significance of these stocks is that, they represent stable business with predictable future earnings.

Example: Top 3 large cap mutual funds operating in India based on their returns in last 10 years.

Types of Mutual Funds - LargeCap Funds - Sharpe Ratio2

Note 1: The above table can be read like this:

  • To generate 9.70% p.a. return in 3 years, large cap fund’s yields a sharpe Ratio of 0.40.
  • To generate 13.84% p.a. return in 5 years, large cap fund’s yields a sharpe Ratio of 0.67.
  • To generate 14.91% p.a. return in 10 years, large cap fund’s yields a sharpe Ratio of 0.62.

Note2: Comparison between index, multi-cap, and large cap funds in terms of their sharpe ratio pans out like this:

Sharpe Ratio3Y5Y10Y
Index Funds0.590.610.56
Multi Cap Funds0.510.820.71
Large Cap Funds0.40.670.62

Large cap mutual funds scores low in comparison to index and multi-cap funds in all time horizons (3Y, 5Y and 10Y).

#1.4 Mid Cap Funds

These types of mutual funds invests in relatively smaller companies. The significance of these companies is that, they are neither too big nor too small. Hence they provide a better prospect of future growth. But on down side, these companies are relatively riskier than large cap stocks.

Example: Top 3 mid cap mutual funds operating in India based on their returns in last 10 years.

Types of Mutual Funds - MidCap Funds - Sharpe Ratio

Note 1: The above table can be read like this:

  • To generate 9.08% p.a. return in 3 years, mid-cap fund’s yields a sharpe Ratio of 0.42.
  • To generate 19.15% p.a. return in 5 years, mid-cap fund’s yields a sharpe Ratio of 0.90.
  • To generate 19.99% p.a. return in 10 years, mid-cap fund’s yields a sharpe Ratio of 0.80.

Note2: Comparison between index, multi-cap, large cap, and mid-cap funds in terms of their sharpe ratio pans out like this:

Sharpe Ratio3Y5Y10Y
Index Funds0.590.610.56
Multi Cap Funds0.510.820.71
Large Cap Funds0.40.670.62
Mid-Cap Funds0.420.900.80

Mid-cap funds scores best in comparison to index, multi-cap, and large funds in 5Y and 10Y time horizons.

#1.5 Small Cap Funds

These types of mutual funds invests in smaller companies. The significance of these companies is that, they are small, hence can grow really fast. But these small-cap stocks pose significantly higher riskier than other stocks. This is where we often encounter penny stocks.

Example: Top 3 small cap mutual funds operating in India based on their returns in last 10 years.

Types of Mutual Funds - SmallCap Funds - Sharpe Ratio2

Note 1: The above table can be read like this:

  • To generate 8.70% p.a. return in 3 years, small-cap fund’s yields a sharpe Ratio of 0.43.
  • To generate 20.31% p.a. return in 5 years, small-cap fund’s yields a sharpe Ratio of 0.97.
  • To generate 18.23% p.a. return in 10 years, small-cap fund’s yields a sharpe Ratio of 0.71.

Note2: Comparison between index, multi-cap, large cap, mid-cap, and small cap funds in terms of their sharpe ratio pans out like this:

Sharpe Ratio3Y5Y10Y
Index Funds0.590.610.56
Multi Cap Funds0.510.820.71
Large Cap Funds0.40.670.62
Mid-Cap Funds0.420.900.80
Small-Cap Funds0.430.970.71

For 5Y period, small cap funds yields the best sharpe ratio (0.97). But for 3Y and 10Y periods, index funds and multi cap score better respectively.

#1.6 Sector Funds

These mutual funds buy stocks from a specific sector only. For example, Technology based sector fund will buy stocks of only tech companies. Significance of sector funds is that, if an individual is bullish on a particular sector in India, he/she can invest in a basket of stock from that sector. How to do it? Buy that sector specific mutual fund.

Here I will present you a data related to mutual funds categorised on basis of sectors in which they operate:

Types of Mutual Funds - Sector Funds - Sharpe Ratio

From the above table, one thing is obvious, out of all sector funds, FMCG sector funds are a clear winner.

Note 1: The above table can be read like this:

  • To generate 14.64% p.a. return in 3 years, FMCG based fund’s yields a sharpe Ratio of 0.77.
  • To generate 16.26% p.a. return in 5 years, FMCG based fund’s yields a sharpe Ratio of 0.87.
  • To generate 21.78% p.a. return in 10 years, FMCG based fund’s yields a sharpe Ratio of 1.15.

Note2: Comparison between index, multi-cap, large cap, mid-cap, small cap, Sector funds in terms of their sharpe ratio pans out like this:

Sharpe Ratio3Y5Y10Y
Index Funds0.590.610.56
Multi Cap Funds0.510.820.71
Large Cap Funds0.40.670.62
Mid-Cap Funds0.420.90.8
Small-Cap Funds0.430.970.71
Sector Funds (FMCG)0.770.871.15
Sector Funds (Fin Serv)0.640.710.57
Sector Funds (Tech)0.450.460.84

For time horizons of 3Y & 10Y, FMCG based sector funds yields best Sharpe ratios. For 5Y period, Small-cap funds had better Sharpe Ratio.

#1.7 Equity Linked Savings Scheme (ELSS)

ELSS Funds are very similar to multi cap funds in terms of portfolio composition. But it differ in two ways with multi-cap funds:

  1. It can save tax u/s 80C.
  2. It has a lock-in period of 3 years.

Example: Top 3 ELSS funds operating in India based on their returns in last 10 years.

Types of Mutual Funds - ELSS Funds - Sharpe Ratio2

Note 1: The above table can be read like this:

  • To generate 10.85% p.a. return in 3 years, FMCG based fund’s yields a sharpe Ratio of 0.51.
  • To generate 12.28% p.a. return in 5 years, FMCG based fund’s yields a sharpe Ratio of 0.80.
  • To generate 13.32% p.a. return in 10 years, FMCG based fund’s yields a sharpe Ratio of 0.70.

Note2: Comparison between index, multi-cap, large cap, mid-cap, small cap, Sector, and ELSS funds in terms of their sharpe ratio pans out like this:

Sharpe Ratio3Y5Y10Y
Index Funds0.590.610.56
Multi Cap Funds0.510.820.71
Large Cap Funds0.40.670.62
Mid-Cap Funds0.420.900.80
Small-Cap Funds0.430.970.71
Sector Funds (FMCG)0.770.871.15
Sector Funds (Fin Serv)0.640.710.57
Sector Funds (Tech)0.450.460.84
ELSS0.510.800.70
Types of Mutual Funds - Top Sharpe Ratios

#2.0 Debt Based Funds

As the name suggests, debt based funds will have a portfolio heavily loaded with debt instruments. But this does not mean that all debt based mutual funds are same.

Debt based funds can be further divided into the following types:

  • Short Term Debt Funds:
    • Money Market Funds.
    • Liquid Funds.
  • Long Term Debt Funds:
    • Government Bond Funds (GILT).
    • Credit Risk Funds.
    • Floating Rate Funds.
    • Fixed Maturity Plan Funds (FMP’s).

Debt based funds are much safer investment option as compared to equity funds. What does it mean? It means, their returns are more assured than equity.

But on down side, the return of debt based funds are much lower compared to equity funds.

How does this information (assured but low returns) about debt based funds effect the Sharpe Ratio?

Generally speaking, majority debt based funds has a higher Sharpe Ratio than equity based funds. Does this make debt funds better than equity funds? Not at all. Equity and Debt based funds cannot be compared with each other based on Sharpe Ratio.

In fact one shall not compare them anyways. We must compare apple to apple. Means, compare equity with equity funds, and debt with debt funds.

So allow me to present you the potential return & sharpe ratio generated by few types of mutual funds which are debt based.

Sharpe Ratio of Debt Based Funds:

Sharpe Ratio1Y3Y5Y10Y
Money Market Funds7.955.825.273.92
Liquid Funds10.817.146.124.80
GILT Funds0.660.730.870.24
Credit Risk Funds0.891.651.891.12
Floating Rate Fund2.822.872.832.54
FMP – Ultrashort Term Bond8.245.485.484.08
FMP – Short Term Bond3.293.193.452.50
FMP – Intermediate Term Bond2.272.132.56 –

Note 1: Liquid Funds have yielding best Sharpe Ratio in 1Y, 3Y, 5Y & 10Y time horizons.

It must also be noted that Sharpe Ratio of debt funds are high compared to equity based funds.

But does this make debt funds more likeable. Yes and No.

Yes, because higher sharpe ratio means higher returns per unit risk taken.

No, because even though sharpe ratio of debt funds are high, but these funds can never beat inflation in long term

So, before getting mislead by high sharpe ratio of debt funds, one must look at return potential of debt funds.

Returns of Debt Based Funds:

Returns %1Y3Y5Y10Y
Money Market Funds7.057.207.797.55
Liquid Funds6.896.877.537.46
GILT Funds6.288.089.576.06
Credit Risk Funds5.537.758.687.57
Floating Rate Fund6.937.518.007.58
FMP’sN/AN/AN/AN/A

Note 1: The above table can be read like this:

  • Money Market Funds: Generate max returns in 1Y time horizon (7.05%).
  • GILT Funds: Generate max returns in 3Y time horizon (8.08%).
  • Gilt Funds: Generate max returns in 5Y time horizon (9.57%).
  • Floating Rate, Liquid, & Money Market Funds: Generate max returns in 10Y time horizon (~7.55%).

How to make sense of this analysis?

If priority is to earn high returns via debt based funds, follow the return table.

If priority is to earn high returns with a level of certainty (assurance), follow the Sharpe Ratio table.

#2.1 Money Market Fund

This type of mutual fund is suitable for investors whose investment horizon is one year or less. Remember, this time horizon is very low in investment terms. Hence, investors expectation for returns shall also be low. Money market funds are a good alternative for people who want to invest but would like safety like bank’s savings account. Such people can park their extra savings in money market funds. They will remain equally safe. How?

Because money market funds invests primarily in T-Bills, Repos, Certificate of Deposits, commercial papers etc. The income earned by the money market fund’s portfolio is mainly in the form of “interest”.

#2.2 Liquid Funds

Liquid funds also invest in money market instruments like T-Bills, Repos, Certificate of Deposits, commercial papers etc. Hence in terms of portfolio composition, they are same as money market funds. But the objective of liquid funds is to emulate the bank’s savings account. What does it mean?

People who keeps money in savings account, can see liquid funds as a better alternative. These liquid funds can also offer linked Debit Cards etc. Hence money parked in liquid funds is almost as good as savings account.

#2.3 Gilt Funds

In terms of quality of portfolio, perhaps GILT funds are the best. Why? Because if the overall credit rating of a GILT funds’ portfolio is calculated, it will not come below AAA Rating. How? Because they only invest in high quality government bonds. What does it mean for the investors. Almost negligible chance of default even in long term.

People who wants to invest with the objective of capital protection even in long term, shall consider GILT funds. These funds will not give returns like equity, but the money parked in GILT funds are safest.

#2.4 Floating Rate Funds

This type of mutual fund is not for everybody. Why? Because it will meet its purpose only in a specific economic scenario. How? As the name indicates, these type of mutual funds invest in those debt instruments which has floating interest rates (like bank loans, bonds etc). So, when interest rate falls, interest paid by these funds also falls and vice versa.

What does it mean for the investors? This type of mutual fund will give better returns only in rising interest rate regime.

#2.5 Fixed Maturity Plans (FMP’s)

They very closely resemble banks fixed deposits, but they are not fixed deposits. Why? Because their returns are not fixed. Moreover, it is important for investors to remember that FMPs are mutual funds, not bank’s issued fixed deposits. Hence there will be a difference?

What are the differences? Good and bad both.

Good is, over a period of time they can give as much returns as fixed deposits. But net of tax returns of FMPs will be better than fixed deposits. How? Because they provide indexation benefits.

The bad side is, as FMPs are mutual funds, their NAV’s change every day. It means their is a volatility factor attached to FMPs. Means, there is a chance that, at end of the period FMPs will yield below par returns. Another down side is, FMPs comes with a lock-in period (low liquidity).

Conclusion…

There is a huge range of the types of mutual funds available for investors in India.

I have tried to elaborate the utility of equity and debt based mutual funds with two perspective:

  • How much return they can yield?
  • How much relative risk they take to generate returns?

As an investor we would like to invest in those funds which generates our desired returns by taking minimum risks.

What does it mean?

Just for hypothesis, consider that there is an index fund which yields 12% p.a. returns. In the same time period there are bank deposits which are yielding same 12% returns. You will buy index funds or bank deposits? Surely bank deposits. Why? Because their returns are assured.

But more important for investors is to look inward first. Meaning?

Generally when it comes to investment, what do we see first? Probable returns that we can earn from our investment options (like stock, mutual funds etc), right? But what really we shall do? Look inward. How?

  • First fix a goal (You are investing for what)?
  • Fix your expectation (what realistic returns shall be expected)?
  • Define risk (How much risk I can take)?

Once the clarity of the above is reached, one can go ahead and start picking the investment vehicle.

Depending on your goal, one can use this blog post to select the right types of mutual funds for their needs.

Have a happy investing.


Hi. I’m Mani, I’m an Engineering graduate who in pursuit of financial independence, has converted into a full time blogger. After working in the corporate world for almost 16+ years, I bid it adieu....read more

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