What are the different types of mutual funds?

Mutual funds continue to ride the passive-investment gravy train, ending 2021 with nearly $500 billion in assets under management, a six-fold increase from just $100 billion in 2011. Driven by increased disposable incomes and low-interest rates, there are few other investment avenues for the middle-class to generate risk-adjusted inflation-beating returns consistently.

Despite the robust performances posted by leading funds over the past few years, most investors often remain naive and unaware of the features and intricacies of where their funds are parked. Most retail investors are also underinformed regarding the various types of mutual funds and options available to them.

This post will provide a brief overview of the various types of mutual funds and the new innovations in this sector that investors need to be aware of. If you’re a stranger to this topic, you can consult PGIM India’s “What is a Mutual Fund” for more information.

1) Equity Funds

As the name suggests, these funds pool money and allocate a majority of it to publicly traded equities based on their own respective investment philosophies. 

This type of fund is as old as mutual funds itself, and while they offer outsized returns in bullish markets, they also witness significant drawdowns during downturns. They are mainly suited for young investors with a high-risk appetite.

2) Debt Funds

With interest rates on fixed deposits hitting all-time lows, there has been considerable interest in debt funds, which primarily allocate investor funds across a basket of fixed-income securities, ranging from sovereign debt, corporate bonds, gilt funds, etc.

These funds allocate money across various assets to minimize risks while increasing returns to investors and are ideally suited for pensioners, investors looking for fixed-income.

3) Hybrid / Balanced Funds

Giving the best of both worlds, hybrid funds provide investors exposure to high-growth, high-risk equity markets, along with the relative security and consistent income associated with fixed-income securities.

Such funds often employ an optimum mix of equity and debt, generally in the 40% and 60% range, respectively. They also involve substantial financial engineering to hedge against downturns while maximizing opportunities for risk-adjusted returns for investors.

4) Liquid Funds

Also referred to as the money market fund, liquid funds are similar to debt funds but often invest in instruments with tenures starting at just 90 days. 

As expected, the rate of returns is lower than long-term debt investing, but it also carries lower risks, with very few chances of default. Such funds are great to park excess cash reserves, given their short-term nature and better return rates than bank interest.

5) Index Fund

An index fund aims to closely track the performance of an index, segment, commodity, or portfolio. Often traded as mutual funds or exchange-traded funds, these vehicles pool funds into a basket of debt and equities to generate returns similar to those of indices. 

They are often not actively traded and are thus known to have a low expense ratio. The fund aims to reduce variances between its own performance and that of the asset it tracks as much as possible. 

Indexed funds are considered the epitome of the passive investing trend.

Final Verdict 

While these are the most popular variants of mutual funds, this sector has been home to wide-ranging innovations catering to the ever-changing savings and investment requirements of retail investors. 

Newer hybrid variants of funds continue to crop up each year, growing and gaining traction in India’s burgeoning asset management industry. These are truly exciting times, and investors who want to get in on the action should stay informed of the latest trends in this niche.