Equity mutual funds or simply equity funds are those that invest predominantly in equity share of companies. There are a variety of ways in which an equity portfolio can be created for investors. The following are the different kinds of equity funds:
1. Simple Equity Funds
These funds invest a predominant portion of the funds mobilized in equity and equity related products. In most cases about 80-90% of their investments are in equity shares. These funds have the freedom to invest both in primary and secondary markets for equity. One variation of the simple equity fund is the ELSS (Equity Linked Savings Scheme). These funds named variously in mutual fund industry are equity funds formed under a special scheme notified by the Government of India in 1990. According to the provisions of this notification, investment in a specially formed mutual fund product that invests at least 90% of its funds in equity and equity-linked investments is eligible for a tax-rebate, up to a maximum investment of Rs.10,000 under Section 88L of the Income Tax Act. Investors have to hold their units for the minimum lock in period of 3 years, in order to avail of the tax rebate.
2. Primary Market Funds
The primary market funds invest in equity shares, but do so only when a primary market offering is available. The focus is on capturing the opportunity to buy those companies which issue their equity in primary markets, either through a public offer or through private placements.
3. Sectoral Funds
Sectoral funds choose to invest in one or more chosen sectors of the equity markets. These sectors could vary depending on the investor preference and the return-risk attributes of the sector. For example, during the technology boom, when prices of IT companies was rising sharply, investors who wanted to participate in this sector could do so, by investing in sectoral funds, whose investment’s objective was to invest in a few chosen sectors such as information technology, media and telecommunications. Sectoral funds are not as well diversified as simple equity funds, as they tend to focus on fewer sectors in the equity markets. They can exhibit very volatile returns.
4. Index Funds
In a simple equity fund, the fund manager has the mandate to create an investment portfolio of equity shares, according to his understanding of the valuations and returns in the equity markets. The portfolio in this case can be composed from the universe of equity shares available to the fund manager. In other words, the fund manager takes a view on the companies that are expected to perform well, and invests in these companies. This style of creating an equity fund is called active fund management. The risk in active fund management is that the fund managers’ views of companies and their performance can turn out to be right or wrong.
An alternative approach to creating an equity portfolio for investors is to avoid talking views on the performance of companies and instead focus on creating a diversified portfolio that simply replicates an existing market index. In order to track the return performance of markets, market indices of a subset of trading stocks is created. The S&P and CNX Nifty is one such index of 50 large and liquid stocks. If a fund manager creates an equity fund, which will invest in the nifty stocks, in the same proportion as in the index, it is creating an index fund. This strategy is also called passive fund management. The costs of this strategy are lower, and the fund performance virtually tracks the market index. An index fund provides an ideal exposure to equity markets, without the investor having to bear the risks and costs arising from the market views that a fund manager may take.
Equity funds can also be created to invest in equity shares of companies with specific attributes. For example, there are small stock funds which invest only in equity shares of small companies; there are PSU funds which specialize in investing only in PSU stocks; there is a top 100 fund which invests from the universe of the top 100 blue chip equity stocks; there is a select equity fund; which invests from the universe of stocks comprising the A Group companies of the Bombay Stock Exchange; and there is a 30-stock fund that limits the number of stocks in its portfolio to 30 stocks. All these products try to define a subset of the equity market, in terms of size and other attributes and tend to focus on that segment.