Understanding Different Types of Mutual Funds and Their Risks – (Part 2) – Globe Capital Market LTD.
  • 10-Jun-2023
  • Mutual Fund

Understanding Different Types of Mutual Funds and Their Risks – (Part 2)

Let’s continue our exploration and delve into the remaining categories after covering equity funds in part 1 of this article.

Debt Funds: Debt funds are investment vehicles that primarily invest in fixed-income securities such as government bonds, corporate bonds, treasury bills, and other debt instruments. These funds provide investors with an opportunity to earn regular income and preserve capital. In simple word, these funds give investor a sense of predictive cash-flows.

 

Debt funds can be categorized in two ways:

 

  1. Categorization based on Tenor: Debt funds can be classified based on their investment tenor, which refers to the maturity period of the underlying debt instruments. Here are the categories based on tenor:

     

    Sr. No.

    Debt Funds – Tenor Wise

    Scheme Characteristics
    1

    Overnight Fund

    Overnight securities having maturity of 1 day

    2

    Liquid Fund

    Debt and money market securities with maturity of upto 91 days only

    2

    Ultra Short Duration Fund

    Debt & Money Market instruments with average time to maturity of the portfolio between 3 months – 6 months

    3 Large & Mid Cap Fund

    Debt & Money Market instruments with average time to maturity of the portfolio between 3 months – 6 months

    4

    Low Duration Fund

    Investment in Debt & Money Market instruments with average time to maturity portfolio between 6 months- 12 months

    5

    Money Market Fund

    Investment in Money Market instruments having maturity upto 1 Year

    6

    Short Duration Fund

    Investment in Debt & Money Market instruments with average time to maturity of the portfolio between 1 year – 3 years

    7

    Medium Duration Fund

    Investment in Debt & Money Market instruments with average time to maturity of portfolio between 3 years – 4 years

    8

    Medium to Long Duration Fund

    Investment in Debt & Money Market instruments with average time to maturity of the portfolio between 4 – 7 years

    9

    Long Duration Fund

    Investment in Debt & Money Market Instruments with average time to maturity of the portfolio greater than 7 years

    Understanding the characteristics of the above-mentioned funds, if you wish to park your savings for a month for your upcoming trip instead of letting them remain idle in your bank account, which fund would you choose?

    The most suitable fund for this purpose would be a liquid fund. Liquid funds primarily invest in instruments with a maturity period of 91 days or less, making them highly liquid and low-risk investments.

    Now, let’s categorize these funds based on their level of riskiness: –

     

    Debt Funds – Tenor Wise Risk Category
    Overnight Fund Low Risk
    Liquid Fund Low Risk
    Ultra Short Duration Fund Low Risk
    Low Duration Fund Low Risk
    Money Market Fund Medium Risk
    Short Duration Fund Medium Risk
    Medium Duration Fund Medium Risk
    Medium to Long Duration Fund High Risk
    Long Duration Fund High Risk
  2. Categorization based on Issuer: Debt funds can also be categorized based on the issuer of the underlying debt securities. The issuer classification helps investors identify the credit risk associated with the fund. Here are categories based on issuer:
    S. No Debt Funds – Issuer Wise Scheme Characteristics
    1 Corporate Bond Fund Minimum 80% investment in corporate bonds only in AA+ and above rated corporate bonds
    2 Credit Risk Fund Minimum 65% investment in corporate bonds, only in AA and below rated corporate bonds
    3 Banking and PSU Fund Minimum 80% in Debt instruments of banks, Public Sector Undertakings, Public Financial Institutions and Municipal Bonds
    4 Gilt Fund Minimum 80% in G-secs, across maturity
    5 Gilt Fund with 10-year constant Duration Minimum 80% in G-secs, such that the average time to maturity of the portfolio is equal to 10 years
    6 Floater Fund Minimum 65% in floating rate instruments (including fixed rate instruments converted to floating rate exposures using swaps/ derivatives)
    7 Dynamic Bond Investment across duration

    Understanding the characteristics of the above-mentioned funds, if you wish to park your savings for a longer period (more than five years) with the highest level of safety, which fund would you choose?

    The ideal fund for this purpose would be gilt funds. Gilt funds primarily invest in debt securities issued by the government, such as treasury bills and government bonds. These funds are considered relatively safer due to the sovereign guarantee associated with government securities. However, it’s important to note that gilt funds may offer lower returns compared to funds with higher credit risk.

    Now, let’s categorize these funds based on their level of riskiness: –

    Debt Funds – Issuer Wise Risk Category
    Gilt Fund Low Risk
    Gilt Fund with 10-year constant Duration Low Risk
    Corporate Bond Fund Medium Risk
    Banking and PSU Fund Medium Risk
    Floater Fund Medium Risk
    Credit Risk Fund High Risk
    Dynamic Bond High Risk

    Hybrid Funds: Hybrid funds are investment options that mix both stocks (equity) and bonds (debt) in a single portfolio. These funds are designed to give investors a diversified approach by investing in different types of assets.

    In India, there are the different types of hybrid funds available:

    S. No Hybrid Funds Scheme Characteristics
    1 Conservative Hybrid Fund 10% to 25% in equity and 75% to 90% in debt
    2 Balanced Hybrid Fund 40% to 60% in equity and 40% to 60% in debt
    3 Aggressive Hybrid Fund 65% to 80% in equity and 20% to 35% in debt
    4 Dynamic Asset Allocation or Balanced Advantage Fund Investment in equity/ debt that is managed dynamically. Ratio would 0% to 100% in equity and 0% to 100% in debt.
    5 Multi Asset Allocation Fund Investment in at least 3 asset classes with a minimum allocation of at least 10% in each asset class
    6 Arbitrage Fund Scheme following arbitrage strategy, with minimum 65% investment in equity & equity related instruments
    7 Equity Savings Minimum 65% – equity and debt- 10% of total assets. Remaining in derivatives.

    Solution-Oriented Funds: As the name suggests, these funds serve specific purposes such as retirement planning, funding a child’s education, and more. Currently, SEBI (Securities and Exchange Board of India) has classified these funds into two categories:

    S. No Solution-oriented Funds Scheme Characteristics
    1 Retirement Fund Lock-in for at least 5 years or till retirement age whichever is earlier
    2 Children’s Fund Lock-in for at least 5 years or till the child attains age of majority whichever is earlier

    Other Funds:

    S. No Other Funds Scheme Characteristics
    1 Index Funds/ ETFs Minimum 95% investment in securities of a particular index
    2 Fund of Funds (Overseas/ Domestic)/td> Minimum 95% investment in the underlying fund(s)

    Having understood the various categories of mutual funds available to you, we encourage our readers to choose the best fund within their respective categories. As Howard Marks wisely said

    “Investment success doesn’t come from buying good things, but rather from buying things well.”

    It’s important to recognize that everything in the market is cyclical. When interest rates rise, stocks and the market tend to underperform, and vice versa. Therefore, effectively shifting your allocation between debt and equity is crucial for achieving good returns. As an investor, you now understand your need for money, which helps you determine the investment holding period and the amount of risk you can tolerate. This knowledge will assist you in allocating your funds across different mutual fund categories.

    Ultimately, we hope our readers not only enjoy their investment journey but also choose the right funds that provide them with maximum value for their invested money. Happy investing!