Mutual funds are becoming a popular investment tool these days because of many reasons, but the main one is their ability to yield attractive returns as compared to other traditional forms of investment. Speaking of attractive returns, equity funds, which are a category of mutual funds, steal the limelight. Equity funds are known to generate the highest returns and hence, are the most sought-after among all categories of mutual funds. Let us understand all about equity mutual funds from the sections given below.
What are equity funds?
Equity funds are a category of mutual funds that invest in stocks or shares of a company and hence, are often referred to as ‘stock funds’. These funds aim to generate capital appreciation for the investor and hence, are also known as growth funds. Equity funds invest a minimum of 60% of their corpus in equity shares of firms but may also allocate a smaller portion to other securities such as debt and money market instruments. Equity funds, just like any mutual fund are managed by a fund manager who allocates the assets according to the scheme’s investment objective. The information on the proportion of asset allocation will be mentioned in the Scheme Information Document (SID) of the scheme.
Equity funds are either actively or passively managed. In case of active management, the fund manager studies the market, researches about the companies, analyses the performance of these companies, and invests in the best stocks. Passive management, on the other hand, involves a strategy where the fund manager creates a portfolio which will mimic a popular market index such as the Nifty or Sensex.
Equity funds are highly volatile investment vehicles since they are affected by the fluctuations in the market and hence, are associated with a high risk. They are ideal for investors who are ready to take on risk to achieve optimal capital appreciation.
Types of Equity Funds
Equity funds are a broad category of mutual funds and have been classified into the following types, based on different parameters:
- Equity-Linked Savings Scheme (ELSS) - This is a breed of equity funds that offers investors tax deduction benefits and hence, is more popularly known as the tax-saving mutual fund schemes. Investors can avail tax deduction benefit of up to Rs.1.5 lakh under Section 80C of the Income Tax Act, 1961. ELSS is the only equity fund that offers such tax benefits. Another feature that distinguishes ELSS from other equity mutual funds is the lock-in period of 3 years. This means that investors cannot exit the scheme before the completion of this period. ELSS is a diversified equity fund that makes investments in equities of firms across market capitalisations and sectors.
- Large Cap, Mid Cap, and Small Cap - When equity funds are classified on the basis of market capitalisation, they can be of 3 types - large cap, mid cap, and small cap. Large cap equity funds invest in stocks of large cap firms, mid cap funds invest in stocks of mid cap firms, and small cap funds invest in stocks of small cap firms. Large cap firms are those that are ranked 1 to 100 in the market while mid cap firms are those that are ranked 101 to 250. Small cap firms are ranked 250 and above in the market.
- Index funds - These type of equity funds mirror a benchmark index such as Nifty or Sensex. All the stocks in the portfolio of an index fund will consist of the same stocks as in the benchmark index and in the same proportion. As they are passively managed, index funds strive to match the performance of its benchmark index unlike in an actively managed fund that tries to outperform its benchmark index.
- Sector and thematic funds - Mutual funds that concentrate their investments in businesses of a particular sector or industry such as pharma, technology, FMCG, etc., are known as sector funds. Thematic funds, on the other hand, follow a particular theme that can vary from international exposure, multi-sector, commodity exposure, etc. The difference between sector and thematic funds is that thematic funds operate on a broader spectrum than the sector funds.
What are the benefits of investing in Equity funds?
As mentioned earlier, equity funds offer the highest returns among all categories of mutual funds and are the reason why many investors put their money in them. There are many other benefits that equity funds offer and we’ve listed them below:
- Growth of capital - Equity funds are one of the best financial instruments that can offer returns to help investors beat inflation. If the prices of stocks increase, investors will be able to see it as an appreciation in their capital. A substantial amount of wealth can be accumulated by investors over the long-term through investments in equity funds.
- Easy on the pocket - Investments in equity mutual funds can be done through a Systematic Investment Plan (SIP) wherein investors can make investments of as low as Rs.500 a month. This amount is deducted from the investor’s account each month. SIPs are one of the best ways to invest in equity funds as they help in beating the volatility in the equity market.
- Diversification of portfolio - When investors invest in an equity mutual fund, they get exposure to various stocks. So, even if some stocks in the portfolio are not performing well, the investor will still achieve capital gains from the performance of other stocks. In this way, equity funds help investors in the diversification of their portfolios.
- Tax benefits - Investors can enjoy tax benefits by investing in equity-linked funds known as ELSS that have been explained in the previous section. By investing in these funds, investors can get a tax rebate of up to Rs.1.5 lakh from their taxable income which consequently, will reduce their tax liabilities.
- Professionally managed - Equity funds are managed professionally by experts known as fund managers who study the market, analyse the performance of companies, and then invest in the best performing stocks so as to deliver optimal returns to the investor.
- Easy to liquidate - Units of equity funds can be redeemed at any time at the applicable NAVs hence, offering liquidity to the investor. ELSS schemes are an exception to this as investors cannot redeem the units unless the lock-in period is over. Equity mutual funds also let investors buy more units at lower NAVs (Net Asset Value) when there is a fall in the market.
Who should invest in Equity funds?
Since equity funds invest in stocks, they are highly volatile and risky. Therefore, they are ideal for investors who have a high tolerance towards risk and are ready to invest over a long-term horizon, at least for a minimum of 7 to 10 years. Over a long-term investment horizon, equity funds have the potential to yield attractive returns. The decision about which equity funds to invest in can be made depending on the risk appetite and the investment horizon of the investor.