What are Equity Mutual Funds? Know the Types and Benefits

What are Equity Mutual Funds?

Equity Funds are a type of mutual fund that focus on the equities markets. To better understand equity mutual funds, it is important to understand that mutual fund is an umbrella term for professionally managed funds that pool together investments from several investors and invest them in varied asset classes depending on the investors' risk appetite. There are mutual funds that focus exclusively on real estate, while others might invest predominantly in commodities. Equity funds are mutual funds the majority of whose exposure is to the equities markets. As a result, they are also called Growth Funds. The main objective of equity funds is the creation of wealth or capital appreciation. Equity funds manage risk by diversifying their portfolio into a relatively large number of stocks, allowing them to give better returns than traditional savings instruments such as FDs or post office savings deposits.

Types of Equity Funds

Equity funds can be categorized into the following types:

Based on Investment Style

Active Fund - In this fund manager looks for good stocks to invest in. He does analysis, research on companies, and examines their performance.
Passive Fund - Here, the fund manager builds up a portfolio mirroring Sensex or Nifty Fifty.

Based on Investment Strategy

Theme and Sectoral Funds– These funds invest in particular sectors like IT, banking, pharmaceuticals, or they might restrict themselves to theme-based investing such as investing in emerging markets, investing in the international markets and so on.
Focused Equity Fund– These funds invest in a small pool of selected stocks, restricting the upper limit of the pool to 30.
Contra Equity Fund– These funds take a contrarian approach to investing and focus on good stocks that are currently undervalued with the assumption that they will live up to their potential in the long run.

Based on Market Capitalization

Large-Cap Funds - These funds invest most of their capital in companies that are classified as large-cap, which is to say, that they have a market capitalization of Rs. 20,000 crores or more. These funds are less volatile when compared to the mid-cap or small-cap focused funds.

Take a look on Large-Cap Funds

Mid-Cap Funds –These funds concentrate their investments in mid-cap companies that usually have a market capitalization of between Rs. 5000 crores to Rs. 20,000 crores. While mid-cap funds reap better returns than large-cap funds, they also tend to come with greater volatility.
Small-Cap Funds - These funds invest the bulk of their total assets in companies with a market capitalization of less than Rs. 5000 crores. Most companies listed on Indian stock exchanges fall under this category.

Take a look on Small-Cap Funds

Multi-Cap Funds– These funds maintain a healthy allocation of all the above three kinds of stocks to mitigate risk.

Based on Tax Treatment

Equity Linked Savings Scheme (ELSS)– These are schemes similar to mutual funds but in which at least 80% of the investments are made towards equity and equity-related instruments. Their biggest advantage is that investments made in ELSS are eligible for a tax deduction of up to Rs. 1,50,000 under section 80C.
Non-Tax Saving Equity Funds– All equity funds except ELSS are non-tax saving schemes which means there is no special provision that attracts income tax deduction under the provisions of the IT act.

Features of an Equity Fund

Lower Expense Ratio – Mutual funds levy several annual charges on the services they provide. These are collectively known as the expense ratio when they are measured as a percentage of the total size of the fund. SEBI mandates a relatively lower upper limit of 2.5% for mutual funds, allowing investors to extract more value for their money.
Tax Exemption under Section 80C - The Equity Linked Savings Scheme (ELSS) offers tax exemption allowing for greater savings.
Portfolio Diversification- Equity Funds allow you to spread a small amount of capital across several equity shares thereby diversifying your portfolio and mitigating risk

How Does an Equity Mutual Fund Work?

An equity mutual fund is a type of mutual fund that invests primarily in stocks. When you invest in an equity mutual fund, your money is pooled with money from other investors and invested in various stocks. The remaining money is invested in money market instruments, debt securities, etc. The fund's performance depends on the performance of the stocks in its portfolio.

Benefits of investing in Equity Mutual Funds

Investments in equity mutual funds have several benefits such as:

Professional Fund managers– Mutual funds are managed by professional fund managers who manage the assets under their supervision according to the highest standards of portfolio management and following industrial best practices.
Portfolio Diversification– As most equity mutual funds spread out their investments across a number of different stocks, they keep risk under control.
Flexibility of Investment- Option to invest either via systematic investment plan (SIP) or lump sum.
Flexibility of Entry and Exit- Certain kinds of mutual funds such as open-ended funds allow the investor to enter and exit the fund as they please.

How To Invest in an Equity Mutual Fund?

When making any investment decision, it is important to carefully consider your financial goals, risk tolerance, and investment horizon. Investors can be broadly divided into two categories: new entrants and seasoned investors.

New investors: These investors have capital to invest but are looking for the right investment opportunity. Investors with limited time to monitor the investment or lack of expertise in the stock market can choose popular avenues like equity mutual funds. However, it is important to note that various equity mutual funds exist. As an investor, you must do your own research before picking the right one.
Seasoned investors: These investors are well aware of the market and equity mutual funds. However, make sure to diversify equity funds and pick the right ones for your portfolio that can generate potential returns.

Taxation rules of Equity Mutual Funds

Equity mutual funds attract the following kinds of taxes:

Capital Gains Tax

If the holding period is less than 12 months, they are known as short-term capital gains which are taxed at 15%. If the holding period is more than 12 months, the gains are called long-term gains. Long-term gains above 1lakh are taxed at 10%.

Dividend Distribution Tax (DDT)

A dividend distribution tax of up to 10% is levied in case the mutual fund provides a dividend to its investors.

Lumpsum Investment and SIP - Which is Better?

Mutual Funds allow investors to invest in a lumpsum or Systematic Investment Plan (SIP). Lumpsum investment is when you invest a single, large amount of money in a mutual fund all at once. On the other hand, SIP is a method of investing in mutual funds by investing a fixed amount of money every month, regardless of the market conditions. The choice between lumpsum or SIP depends on the investor. Ultimately, your best investment option will depend on your circumstances and risk tolerance. If you are not comfortable with risk, SIP is a good option. If you are confident about the market and have a large sum available, you can consider lumpsum investment.

To Sum Up

Equity mutual funds are a great option for those who want to invest in the equities markets but do not have either the time or the expertise to research and pick good stocks, constantly track their portfolios, and monitor the market conditions. With professional fund managers and the several safety measures built in, equity mutual funds provide the high growth associated with equities at a relatively lower risk as compared to direct participation in stocks.