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 made much easier if you could divide the funds into categories and sub-categories according to their investment characteristics. Then, you can first analyse which category meets your needs gets reduced to a simpler task because a huge number of funds-the ones that are in categories that are unsuitable to you-don't have to be bothered with.
But who is to create the categories? On what basis are they created? How are funds placed in the categories? That's where Value Research comes in.
The purpose of any fund classification system should be to help the investor match his own returns expectations and risk-taking ability with the type of fund that he is going to invest in.
The first thing to understand about fund classification is that it is almost entirely about dividing the entire risk-return continuum into bands of roughly equal return and risk expectations. This makes the real task, that of identifying funds that are likely to generate higher returns at lower risk, easier.
Funds are classified according to the ratio of equity and debt investments in their portfolios.
There are pure equity funds, debt funds and hybrids that have both. Their relative return vs risk levels are obvious. There are also other ways along which equity funds can be classified, for example, which sector or industry they would invest in.
The best thing about having a good classification system for funds is to realise that making a choice is actually quite simple.
- There are so many funds that investors cannot study all of them to decide which one to invest in.
- In closed-end funds, you can redeem your money any time you want.
- Fund classification helps investors:
- Compare funds of the same type
- Find the best match for the returns and the risk they think is appropriate
- Match their horoscope to the fund manager