Know About Equity Funds and Its Types

Equity funds are among the most popular types of Mutual Funds that investors like to add to their investment portfolio. They have high growth and return potential due to a large equity exposure. However, there are numerous types of Equity Funds based on various factors. By knowing their risk-reward parameter, you can select the best types of Equity Funds for your portfolio through lumpsum or SIP. In the following sections, we will explore what is an Equity Fund and its types.

What is an Equity Fund?

Equity Funds are types of Mutual Funds that dedicate a majority of their corpus to equity and equity-linked products and the remaining corpus to money market securities and debts. Fund managers use this strategy to diversify the fund’s overall risk and increase liquidity. Since these funds largely depend on the stock market, they carry more risk than Debt and Hybrid Funds. However, when the market is bullish, they can also provide higher returns than other types of Mutual Funds.

Also known as Growth Funds, these funds promise to generate the best returns when the market conditions become favourable. However, they also have a higher risk involved because their return and performance largely depends on the equity market situation. 

Types of Equity Mutual Funds according to Market Cap segments

Now that you know what an Equity Fund is, let us look at their types based on market cap segments:

• Large-Cap Funds:

  The funds containing stocks that are the among the highest in terms of market capitalisation (Large Cap Stocks) are Large-Cap Funds. They are characterised by their large size, high financial strength, wide public ownership and market leadership in the industry. Investors perceive these stocks as less risky, leading to higher valuations.

• Mid-Cap Funds:

  The stocks that rank immediately after the Large-Cap stocks in terms of market capitalisation are Mid-Cap stocks and the funds that invest in them are called Mid-Cap Funds. These are usually smaller companies (by revenues and Market Cap) compared to Large-Cap companies. However, Mid-Cap stocks have higher growth and return potential. They might become Large-Cap stocks in the future, giving potentially higher returns in the long term.

• Small-Cap Funds:

  Small-Cap Funds are those funds that invest in the stocks of smaller companies, smaller by market capitalisation and possibly revenues. Small-Cap Funds are the riskiest types of Equity Funds. However, they can potentially deliver higher returns than Mid-Cap and Large-Cap funds in the long run. They are unsuitable for short-term investments because they can be volatile and illiquid. Most Small-Cap companies are largely owned by promoter(s) and the percentage of free-float is much less than Mid-Cap and Large-Cap shares.

You will also come across Multi-Cap Funds that invest across multiple industry sectors and cap segments without any minimum or maximum limits for investment.

Types of Equity Mutual Funds according to investing styles

Equity Funds can be of different types based on their investing styles:

• Value Funds:

  These funds use a value investing strategy by investing in companies trading at a discount. Difference in their actual and potential valuation is termed as the margin of safety. Fund managers estimate a stock’s intrinsic value after the company’s in-depth analysis. Notable features of value stocks include low price-earnings, discounted rates to book multiples and higher dividend yields. Some investors also call value investing contra-investing.

• Dividend Yield Funds:

  These equity Mutual Funds predominantly invest in stocks with high dividend yields. It is the ratio of dividends per share that a stock pays to its market price. Usually, mature companies provide high dividend yields owing to their stable cash flows and business models. Hence, they have a low risk involved.

• Focused Funds:

  According to the Securities and Exchange Board of India’s (SEBI) mandate, Focused Funds can invest in not more than 30 stocks. Since the number of stocks available for investment is limited, they have a higher risk due to concentration rather than diversifying the Equity Fund investment. If the fund manager selects the right funds, they have the potential to deliver superior returns.

• Thematic or Sectoral Funds:

  SEBI makes it compulsory for these funds to invest at least 80% in a particular theme or sector. Here, it is crucial to understand the difference between theme and sector. Sectoral Funds invest their assets in a specific industrial sector like technology, banking, FMCG, pharmaceuticals, infrastructure, etc. On the other hand, an investment theme is more diverse, encompassing multiple sectors. For instance, the theme of consumption might cover various sectors, including banking, finance, automobiles, media and entertainment, consumer durables and non-durables, etc. Similarly, the healthcare theme may cover sectors like pharmaceuticals, hospitals, health insurance, wellness products, diagnostic centres, etc.

• Equity Linked Savings Schemes (ELSS):

  Equity Linked Savings Schemes or ELSS are diverse Equity Funds with a 3-year lock-in period. That means you cannot redeem these units for at least three years from the investment date. If you invest in an ELSS SIP scheme, each instalment will have a lock-in period of three years. ELSS investments of up to Rs 1.5 lakh are eligible for tax deduction under Section 80C of the Income Tax Act. That means you can save up to Rs 46,800 (surcharge extra) in taxes by ELSS investment. Past performance suggests that ELSS funds can generate superior returns in the long run compared to other tax-saving schemes like PPF, NSC, life insurance policies, tax-saving FDs, etc. However, since ELSS schemes are market-linked, they are riskier than other traditional instruments. Moreover, they follow multi-cap strategies to diversify the portfolio. The lock-in period of three years benefits the investors, as fund managers cannot redeem them, letting them stick longer and generate superior returns in the long run. Financial experts suggest investing in ELSS for longer than three years to get better results over longer investment horizons.

Capital appreciation is the primary objective of investing in Equity Funds. Apart from that, you can also enjoy tax benefits by investing in an ELSS scheme. However, you should hold your investment for the longest possible tenure and be ready with a high-risk appetite to invest in an Equity Fund.

Now you know what an Equity Fund is and its types. Invest according to your budget and risk appetite and choose one that best suits your investment goals.