The equity market is where public capital meets the real market. Run perfectly, equity capital markets provide a win-win deal for both capital seekers; i.e. businesses and investors. However, not all investors have enough time, skills or resources to ensure they know where they are investing.
Equity mutual funds aim to fill this gap and ensure your money has professional insight and acumen while moving around in equity markets. No doubt, the possibility of market-linked returns and reliable management has made equity mutual funds a popular choice. The fiscal year 2017-18 witnessed 1.6 crore investors, and this was twice the number of investors in the financial year 2015-16 and 2016-17.
Here is what makes equity mutual funds unique and popular investment option for you:
What is Equity Mutual Fund?
An equity fund is a mutual fund that invests principally in stocks. It can be actively or passively (index fund) managed. Equity funds are also known as stock funds.
Equity mutual fund is a reliable way of investing money in stocks, even when you want to start small. Or, more specifically, especially when you want to start small. For example, if want to buy one common stock of MRF Ltd. on the stock exchange, you will need to invest about Rs. 50 to 60,000. Whereas, you can start investing in an equity mutual fund with just Rs. 5000.
Types of Equity Mutual Fund
Equity mutual fund is available in three categories that include:
- Types of stocks they invest in
- The objective of the fund
- The portfolio management style
1. Equity Funds based on Market Capitalization
In 2018, SEBI i.e. Securities and Exchange Board of India classified mutual funds in the below-mentioned categories.
| Large-cap equity funds | These are reputed companies with the establishment of several years. Hence they are always in the situation to offer high ROI i.e. return on investment. |
| Mid-cap equity funds | The investment takes place in the companies that have medium-scale capital. The ROI on equity fund here is little less than large-cap equity funds. |
| Small-cap funds | Investment in companies with small capital includes risk as the investment has exposure to fluctuating market behaviour. |
2. Equity Funds Based on Investment Objectives
While there could only be two objectives of any equity mutual fund – capital growth or regular income (dividend pay-out).
| Capital Growth Funds | Capital growth funds focus on maximizing the NAV of the fund by reinvesting any income they receive from the stocks. Since the funds don’t pay anything back to the investor, there is no dividend distribution tax. In the case of partial withdrawal, you need to sell units to withdraw funds. |
| Dividend Funds | These funds with an objective of dividend pay-out may simply pay the gains out regularly as dividends. This dividend is different from the stock dividend the funds received. Fund’s dividend is based on the total income of the fund from the investments, which will include any capital gains from the sold shares. |
Still, the fund is expected to pay a dividend distribution tax on the distributed income. As an investor, you can reinvest your dividend in the fund for additional units and enjoy compounded growth.
Almost all the funds will provide both the options to you at the time of investment. Since NAVs for both options are different, fund management is also different for both.
For example, you want to invest in BSL India Sector Fund, you will encounter the BSL India Sector Fund – Growth Option & BSL India Sector Fund – Dividend Option.
3. Equity Funds Based on Portfolio Management Style
| Dividend Yield Fund | Here, the dividend payable/unit is divided by the market value. The equity mutual fund here is an investment in the equity of the company that disburses profit as divided as and when the company makes a profit. |
| Value/Contra Fund | This fund is known for flowing in the opposite driven. Enjoy a return on investment here as the companies falling under this type are known for yielding returns by challenging the current/opposite market situation. |
| Equity Linked Saving Scheme | Commonly known as ELSS here, the investment is a lock for the tenure of 3 years. The investment via the Systematic Investment Plan (SIP) gets Income tax rebate under section 80(C). |
| Sector-Based Fund | The equity fund focused on a dedicated sector or theme is known as the sector-based mutual fund. Such investment plans rely upon companies related to the same industry type. The sector-based mutual fund is a risky investment as its performance depends on the market behaviour of few companies. |
4. Other Classifications – Passive & Active Equity Funds
An equity fund based on its investment objective could be actively managed or passively managed.
| Actively Managed Funds | Any fund which aims to cash market opportunities and actively trades in the stocks for capital gains or dividend income can fall in this category. In fact, almost all funds, except index funds and ELSS schemes are actively managed funds. |
| Passively Managed Funds | Passively managed funds usually follow a benchmark index as an ideal stock portfolio and try to imitate it as much as possible. Thus, the stock holding of these funds may not change as frequently as actively managed funds. Also, these equity funds have lower fund management charges than actively managed funds. |
How Does Equity Mutual Fund Work?
The moment you invest in a mutual fund, you buy its units and become the unitholder of the fund. This is where the work of an equity mutual fund starts, and continues until you liquidate, or sell, the units and withdraw your money.
Also, before we get into how the money travels within the fund, we should note a couple of things:
- Fund’s total assets are called AUM or asset under management, this will include all the cash, stocks and bonds held by the fund
- Every fund except liquid funds must keep a percentage of AUM in cash and liquid assets (call cash reserve) to maintain liquidity
- Mutual fund schemes receive multiple investments and withdrawal requests every day
- Any mutual issues most new units at the time of NFO
Here’s what happens between these two points within an equity fund:
The process is simple. However, the major part of the AMC’s role is into market research, stock selection, and risk management. All of these activities occur in Stage 2.
Also, you may notice that the fund does not always need to issue new units or sell stock holdings with every investment or withdrawal. This means, that while you are withdrawing, the fund may not actually have to sell equivalent stocks to give you the money.
What is NAV?
NAV is the net worth of the mutual fund divided between all the units the fund has issued. Simple NAV formula for a fund would be:
[Total AUM (asset under mgmt.) – Current Liabilities] / No. of Units in the Market
In India, equity funds must publish their NAVs every day. Whenever you buy new units you pay as per the day’s NAV for those units, and at the time of withdrawal, you will sell the units back to the fund (usually) at the day’s NAV.
Changes in a fund’s NAV over time indicates the fund’s performance over time. The greatest factor affecting an equity fund’s NAV is the valuation of stocks in the fund’s portfolio plus any dividend income.
Does NAV show the popularity of a fund?
Not really, you should look at the total AUM of a fund to judge its popularity. NAV is only a representative value of all the assets the fund has invested in minus any liabilities.
Can You Calculate Mutual Fund’s NAV?
Obviously yes. However, you will need to study the valuation rules for equity mutual funds. These rules define the parameters AMCs can use while determining the value of a stock in their portfolio.
Features of Equity Mutual Fund
1. Diversification
Diversification is one of the most effective ways of reducing your risk of investing in stocks and optimizing your long-term ROI. Equity mutual funds offer you the opportunity to hold a well-diversified portfolio.
2. Professional Management
Equity mutual funds give you the opportunity to invest your savings in a professionally managed portfolio. Given the fact that you should dedicate most of your time to your profession, your investments could suffer from lack of attention.
Equity mutual funds allow you to get the best possible management for your equity market investments.
3. Start Small
If you want to build a strong diversified portfolio of equity stocks with your monthly savings, chances are you will fall short by a huge margin. But equity mutual funds handle this problem far more efficiently.
While investing in a well-diversified equity fund you can invest in a portfolio of up to 30 stocks, even when you invest only Rs 5000.
4. Systematic Investment Option
Systematic investing or investing small amounts regularly is one of the best ways to lower your equity market risk and maximize returns. Equity mutual funds allow you to automate your regular investments in the market systematic way.
You can start SIPs into equity funds directly from your salary account and ensure rupee cost averaging for your portfolio.
5. Tax Saving
ELSS mutual funds or equity-linked savings schemes are the only pure equity investment options which will help you save tax under section 80C. Equity-linked saving schemes are passively managed as they follow a set benchmark index for stock selection.
These equity schemes have a lock-in period of 36 months. So, you will need to hold the ELSS units for at least 36 months before you can withdraw from the fund.
Who should Invest in Equity Mutual Funds?
As they say, the fruit of a tree doesn’t fall far from it, equity funds have a risk-return profile like the asset they hold most dearly; i.e. equity stocks. However, being large portfolio equity funds offer many advantages over individual stocks as we have seen earlier.
Equity funds are a risky proposition despite all the diversification, professional management and systematic investment. Thus, you should invest in equity funds if any of the following conditions apply to you:
- Long-Term Financial Goal: Ideally you should be comfortable parking your savings for at least 5 to 10 years. So, it makes sense to use equity funds for financial goals which will occur at least after 5 to 10 years.
- Young Investors: If you are in your 20s, have little financial responsibilities and reasonable savings, equity funds could be great for you. As responsibilities start catching up near the age of 30 or afterwards, you would have built substantial wealth from equities.
- Wealth Creation is Your Financial Goal: There could be better options than equity funds for building wealth. But they are either rare to find or need substantial investment in both time and money to work. Equity funds, however, are simple to operate, start and need little attention from investors for at least 5 to 10 years period.
Benefits of SIP in Equity Funds
1. Easy Investment
Not many people can invest a huge sum of amount in one go. But, they can surely save a small amount of money. The SIP [Systematic Investment Plan] give investors the privilege to deposit a fixed small amount once in a month.
2. Best to Create Wealth
Many people wait for the right time to invest. But the secret to long-term wealth is to start early, even if small, and be consistent. The SIP mode of investing helps you achieve just that.
3. Rupee-Cost Averaging
Usually, SIP is a better option than investing a huge amount in one-go and SIP is only possible due to the rupee-cost averaging. As per rupee-cost averaging, an investor would purchase a greater number of mutual fund units when the prices are low and will not buy when the prices are high.
This is an ideal way to maximise your chances of returns by from equity mutual funds.
Taxation of Equity Mutual Funds
For regular citizens of India
The equity mutual fund is a taxable investment in India and subject to short and long-term capital gain tax:
- The long-term Capital gains tax rate is 10% if your total long-term capital gain is more than Rs. 1 lakh in the financial year
- Short-term Capital Gains arise when you sell the equity fund units within 12 months of purchase. The tax rate on the gains will be 15% in this case.
For Non-Residents of India
The tax implications are the same for NRIs also. The TDS (Tax Deduction at Source) applicable on Short term Capital Gains stands at 15% and 10% for Long term Capital gains.
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