This classification tree will help you understand the different types of mutual funds
01-Mar-2022 •Research Desk
There are hundreds of mutual funds in India. If you were to try and understand each one individually before deciding which is suitable to invest in, you are taking on a near impossible task. However, the challenge is made easier once you divide the funds into categories and sub-categories according to their investment characteristics. You may then start analysing which category meets your needs.
Value Research has been classifying funds based on their underlying investments for a long time, much before the market regulator SEBI came up with a classification system to standardize fund categories for all asset management companies (AMCs) in October 2017. Though our own classification system was quite similar to the one mandated by SEBI, but we fine-tuned it to align more closely with that of the regulator.
The purpose of this fund classification system is to help investors match their expectations and risk-taking ability with the type of fund. The first thing to understand about fund classification is that it is almost entirely about dividing the whole risk-return continuum into bands of roughly equal return and risk expectations. This makes the real task of identifying funds that are likely to generate higher returns at lower risk easier.
At the broadest level, funds are classified according to the ratio of equity and debt investments in their portfolios. There are pure equity funds, debt funds and finally, hybrid funds that have both equity and debt. Their relative return vs risk levels are obvious. Within this first level of classification, the primary criterion for classifying equity funds is the size of the companies they invest in. There are funds that mostly focus either on large companies or medium-sized or small companies and there are also those that keep their assets distributed among all of these in some ratio. There are other axes as well along which equity funds can be classified, like the sector or industry they invest in.
In the accompanying infographic, the first level depicts the basic asset types. These are equity, debt (fixed income) and hybrid. There's also another bucket in which we have placed gold and silver funds since they don't fall into any of the other categories. Equity, debt and hybrid funds are further subdivided into smaller categories based on other characteristics.
If you go by how fund companies describe their funds, you will end up with a large number of similar funds that appear to be unique or near-unique. You may feel there aren't too many other funds like them. However, this apparent uniqueness is a marketing imperative. It is something that has been invented by fund companies in order to appear different from other funds.
However, an investor's interest is best served by keeping things simple. The best thing about having a good classification system for funds is it helps you realise that making a choice is actually quite simple and a vast majority of funds can be conveniently ignored.