Types of Mutual Fund Based on Organisation, Management, Objective and Asset Class

In the previous chapters, you have understood mutual funds, their working, and the meaning of their Net Asset Value [NAV]. Now, it's time to understand the various classifications of mutual funds. 

Understanding the Meaning of Investment Schemes 

Mutual funds are also called collective investment schemes or simply investment schemes. 

As per the Securities and Exchange Board of India (SEBI), “Any scheme or arrangement made or offered by any company under which the contributions, or payments made by the investors, are pooled and utilised to receive profits, income, produce or property, and is managed on behalf of the investors is a Collective Investment Schemes (CIS). Investors do not have day-to-day control over the management and operation of such schemes or arrangements.”

Understanding Mutual Funds Classification 

There are hundreds of mutual funds in India. If you were to try and understand each one individually before deciding which is a suitable one to invest in, it would be an impossible task. However, the task is easier if you divide the funds into categories and subcategories according to their investment characteristics. This is precisely what SEBI has done. They have categorised the mutual fund schemes to help investors make informed decisions. 

You can first analyse which category meets your needs. This simplifies the process, as you can then focus on a smaller set of funds, eliminating those in unsuitable categories.

There are various types of mutual funds present in the market for investors, and they are categorised based on:

• Organisation Structure
• Management style
• Investment objective 
• Asset class 
• Other types of funds

This chapter will focus on understanding the types of mutual funds based on organisation structure, management style and investment objective. The rest of the classifications will be covered in detail in the upcoming chapters. 

Funds Based on Organisational Structure

The classification of mutual funds based on this category is based on how a fund is managed or operated. Three main types of funds under this classification are Open-ended funds,  Closed-ended funds and interval funds.

• Open-Ended Mutual Fund:

Some of the prominent characteristics of open-ended mutual funds are:

• This category of mutual funds does not have a fixed maturity period. Thus, the fund continues to exist indefinitely unless some external factor impacts its existence. 
• Therefore, even after the New Fund Offer [NFO], investors can buy and sell the mutual fund units at the prevailing NAV. 
• Thus, there are unlimited units, and the fund house continuously issues and redeems units based on investor demand. 
• The open-ended fund’s NAV is calculated based on the underlying pool of securities the fund has invested.
• These funds do not trade publicly, i.e., the units do not trade on stock exchanges. 
• Units are bought directly from the fund by the investors rather than from another investor. 

Thus, open-ended mutual funds are usually suitable for those investors who want to maintain high liquidity and, therefore, may need to redeem mutual fund units if the liquidity need arises. Liquidity here means an urgent need for cash. 

• Closed-Ended Mutual Funds:

As their name suggests, they have characteristics opposite to open-ended schemes:

• The primary difference lies in the maturity difference. Closed-ended funds have a fixed maturity and, therefore, cease to exist after a period of time. 
• These funds have a predetermined number of units, so the fund house does not create or redeem new units. 
• Unlike open-ended mutual funds, units of closed-ended mutual funds are tradable on the stock exchange. Therefore, the units act more like an Exchange-Traded Fund [ETF].
• Although the NAV is based on the underlying values of securities, the fund has invested in. It is also impacted by the demand and supply forces in the market. As mentioned earlier, as the total number of units issued is fixed, if demand is greater than supply, it can lead to an increase in the NAV of a closed-ended mutual fund, even if the prices of the underlying securities are unchanged. In such a situation, the fund trades at a premium to its NAV.
• Investors who want to exit the fund may sell the units in the open market. However, given the limited liquidity and the closed-ended nature, finding a buyer to buy your units at your desired price may also take time and effort.

The table below summarises the difference between the funds:

Feature	Open-Ended Mutual Funds	Closed-Ended Mutual Funds
Maturity	There is no fixed maturity period. It can be held indefinitely.	Fixed maturity period, typically ranging from a few years to several years.
The size of the fund	Can grow or shrink based on investor demand. Continuous issuance and redemption of units happen.	Has a fixed number of units. No new shares are issued after the New Fund Offering (NFO).
NAV	Calculated at the end of each trading day.	Market-driven: the price can differ from the NAV and is determined by supply and demand forces in the secondary market.
Trading of units	Investors can buy or sell the mutual fund units directly from/to the fund house at NAV.	Mutual fund units can be bought and sold on stock exchanges.
Flexibility	Offers liquidity as investors can buy or sell units at any time.	Liquidity depends on the demand in the secondary market; may trade at a premium or discount to NAV.
Capital Structure	Can issue an unlimited number of units based on investor demand.	A fixed number of shares are issued during the NFO; no additional shares are created or redeemed.
Redemption	Investors can redeem units at any time at the prevailing NAV.	Redemption typically occurs at the end of the fund's fixed maturity period.
Price Determination	NAV is the primary determinant of the price.	Market forces (supply and demand) determine the price, which may deviate from the NAV.
Examples	SBI Small Cap Fund, SBI Magnum Gilt Fund,	SBI Tax Advantage Fund – Series III – Regular Plan, ICICI Prudential Growth Fund – Series 2

• Interval Funds 

The interval funds category of mutual funds combines closed-ended and open-ended mutual funds. The characteristics of these funds are:

• The units of an interval fund can be purchased or redeemed only during a specific time interval. 
• The fund house declares these time intervals to buy and sell units.
• Since an investor can redeem the units of an interval fund only during specified time intervals, these funds are highly illiquid. Hence, in any emergency, an investor cannot redeem the units of these funds. 
• Also, an investor cannot sell the units of these funds in any secondary market.
• These funds can be invested in debt and equity categories; however, most of the funds in India are debt-oriented. 

These are the classifications of mutual funds based on organisational structure. Open-ended schemes are the most common types of mutual funds. Closed-ended funds and interval funds are relatively less popular in India. 

• Funds Based on Portfolio Management

• Active Funds

In an active fund, the fund manager is ‘Active’ in deciding whether to buy, sell or hold the underlying securities. Active funds adopt different styles and strategies to create and manage a portfolio.

Although there is a separate chapter dedicated to active investing and working of active funds, let’s just quickly cover the features of active funds in brief:

• The fund's aim is to outperform the benchmark index
• These funds rely on professional fund managers who manage investments.
• Active funds expect to generate excess returns  (alpha) over and above the benchmark index.
• Active funds suit investors who wish to utilise the fund manager’s alpha generation ability. 
• The return and risk profile of the fund will depend upon the fund’s strategy adopted.

• Passive Funds

In contrast to active funds, passive funds hold a portfolio of securities replicating a stated benchmark or index. In a passively managed fund, the fund manager has a passive role to play, as the decisions related to stock selection / buy, sell, and hold are driven by the changes in the benchmark Index, and the fund manager simply needs to replicate the same with minimal error.

For example, Index funds Exchange Traded Funds (ETFs)

Although there is a separate chapter dedicated to passive investing and working of passive funds, let’s just quickly cover the features of active funds in brief:

• Ideal for investors who want their portfolio to mirror a market index and do not want to focus on alpha generation.
• These funds are low cost than the actively managed funds.

Now, let’s move on to our third category of mutual fund classification. 

Funds Based on Investment Objectives

You, as an investor, might have different investment objectives. Therefore, there are mutual funds that offer products that cater to these objectives of the investors, such as –

• Regular Income
• Capital Appreciation (Growth)
• Capital Preservation
• Tax-Saving
• Liquidity

Let’s understand a few of them.

• Growth Funds 

These funds are basically designed to provide capital appreciation to investors. They primarily invest in growth-oriented assets, such as equities. If you wish to invest in such funds, it requires a medium to long-term investment horizon. Historically, it is seen that equity as an asset class has outperformed other assets if held over a longer term. But, returns from growth funds tend to be erratic, especially over a shorter time frame, since the prices of the underlying equities may change. Hence, investors must be able to bear the returns volatility in the short term.

• Income Funds 

The main aim of these funds is to provide steady and regular income to investors. Income funds invest in income securities like - corporate bonds, government securities and debentures. The fund’s return is basically from the interest or coupon income earned on these investments alongside any capital gains from a change in the principal value of securities. The fund will distribute this income to investors if the portfolio generates the required returns. However, note that no form of fixed income is guaranteed. The returns will also depend upon the credit quality and tenor of the securities held.

• Liquid Funds 

Liquid funds invest in securities with residual maturity of up to 91 days. These funds do not have a lock-in period. They are very low risk and provide moderate returns on investment.

Investors who have surplus capital and want to invest for a short period of time can opt for liquid funds. 

• Tax Savings Fund or ELSS

An Equity-Linked Savings Scheme (ELSS) or tax saving fund is a type of mutual fund where the majority of investments of the total assets are made in equity and equity-related instruments. This scheme has a lock-in period of 3 years and qualifies for tax exemption under Section 80C of the Income Tax Act, as per which a tax exemption of approximately    ₹ 1,50,000 is allowed.

How To Invest in Mutual Funds on Angel One?

1. Open the Angel One app. On the Home page, go to ‘Mutual Funds’.
2. Choose the Mutual Fund that you want to invest in from the various lists provided on the Mutual Fund portal.
3. Choose whether you want to invest via lump sum or SIP mode.
4. Enter the amount that you want to invest.
5. Click on the payment button to complete the payment and start your investment.

This sums up our chapter on the classification of mutual funds based on three major categories - Organisational structure, investment objective and portfolio management. In the next chapter, we will focus on types of mutual funds based on different asset classes.