Equity Mutual Funds: Meaning, Types & Features

Have you ever been concerned about how to prepare for your long-term financial goals, such as purchasing a home, planning a child’s marriage, schooling, and so on, but yet to discover the appropriate investment product that will provide inflation-beating returns?

Then someone told you to invest in an equity mutual fund, but you don’t understand what exactly an equity mutual fund is.

In this blog, we’ll discuss the equity categories of mutual funds in detail.

Equity Mutual Fund

Firstly, if you’re new to the mutual fund’s world, then check out our blog on the same: What are Mutual Funds?

Coming to the equity category of mutual funds, the fund manager primarily invests in the equity market. Equity mutual funds generally offer better long-term returns than other categories of mutual funds, but they can be volatile in the short run and carry higher risk.

The fund management and their research team invest the funds in a variety of companies from different sectors or market capitalizations depending on the type of equity mutual fund.

Features of Equity Mutual Funds

1. Equity mutual funds generally offer higher returns than other types of mutual funds, such as hybrid and debt funds.
2. Investors can enjoy tax benefits while investing in ELSS funds, which are a part of equity mutual funds.
3. Equity funds carry higher risk as their portfolios majorly consist of stocks.
4. Investment in equity mutual funds is suggested for the investors with a longer horizon, preferably >5 years.
5. Equity funds tend to have higher expense ratios than other categories of mutual funds.

Types of Equity Mutual Funds

Before jumping into the types of equity funds, let’s first understand the Large, Mid and Small Cap Companies.

There is a concept called Market capitalization, which refers to the total valuation of a company’s outstanding shares. It is calculated by multiplying the total number of outstanding shares by the current share price.

As per our market regulator, i.e., the SEBI, based on the market capitalization, stocks are classified into Large, Mid and Small-Cap:

1. Large-Cap – It refers to the top 100 listed companies on the basis of market capitalization. They are also known as Blue Chip companies and considered less riskier than Mid and Small-Cap companies.
2. Mid-Cap—Companies ranked between 101st and 250th are considered Mid-Cap Companies. They are considered riskier than Large-Cap Stocks.
3. Small-Cap—It refers to the 251st company onwards in terms of market cap. They carry the highest risk.

Categories of Equity Mutual Funds

There are various types of mutual equity funds, and investors can choose among them based on their investment objectives and risk profile.

1. Large-Cap Funds— A large cap mutual fund manager invests a minimum of 80% of their total assets into large-cap stocks (the top 100 stocks based on market capitalization). These funds are less volatile because large-cap companies are considered more stable than large and small-cap.
2. Mid-Cap Funds—A minimum of 65% of total assets are invested in Mid-cap stocks. These stocks have the potential to grow at a higher rate than large-cap stocks, but are also more volatile. Hence, they are suitable for investors who can take a moderate amount of risk on their capital.
3. Small-Cap Funds—These funds invest a minimum of 65% of their total assets in the stocks of small-cap companies. They have the potential to generate higher returns, but they also carry the highest amount of risk. This fund is suitable for risk-taking investors with a longer investment horizon.
4. Large & Mid Cap Funds—The fund invests a minimum of 35% of its total assets in large-cap and 35% in mid-cap stocks.
5. Flexi-Cap Funds—Flexi-cap funds can invest a minimum of 65% of their total assets into equity and equity-related instruments across market capitalization. It gives more flexibility to the fund managers as there are no restrictions regarding the investment based on market capitalization.
6. Multi–Cap Funds—The Multi-cap funds invest at least 75% of their portfolio in equity and related instruments and a minimum of 25% of their total assets in large, mid, and small-cap stocks. It offers less flexibility to the fund manager as compared to the Flexi-cap funds.
7. Focused Funds—This category of equity mutual fund invests a minimum of 65% of its total assets in equity-related instruments. Further, investing in more than 30 stocks at a particular time is not allowed.
8. Sectoral/Thematic Funds—These funds are required to invest a minimum of 80% of their total assets in a particular theme or sector, such as Banking, FMCG, Infra, Healthcare, etc.
9. Dividend Yield Funds—A minimum of 65% of this fund’s assets are invested in dividend-yield stocks.
10. ELSS Funds—In an ELSS fund, the fund manager invests 80% of the total funds into equity and equity-related instruments without any restriction of market capitalization. This is the only equity mutual fund category that comes with a lock-in period of three years, as it offers a deduction of up to INR 1,50,000 under section 80C of the Income Tax Act.

Taxes on Equity Mutual Funds

We have discussed multiple categories of Equity Mutual funds above. However, taxation on almost all equity mutual funds remains the same, whether it is large, flexi, small cap, etc. Ignoring taxation can significantly impact your net returns post taxation.

The capital gains tax on the profit earned by investing in equity mutual funds is divided into two different categories:

1. Short Term Capital Gains Tax (STCG)— If the investment is held for less than 12 months or 365 days, the capital gain generated will be taxed at a rate of 15% without any indexation benefit.
2. Long Term Capital Gains Tax (LTCG) — If the investment is sold after 12 months or 365 days, the capital gain generated will be taxed at a rate of 10% over and above INR 1 lakh.

If you are curious to learn more about the taxation of Mutual Funds in India, check out our blog: Decoding Mutual Funds Taxation in India.

Conclusion

Investment in equity mutual funds can be a good option for long-term wealth creation. It can help you achieve your long-term financial goals and beat fixed-return investment plans.

Further, one can start investing in equity mutual funds with as little as INR 100, and ELSS funds provides a tax benefit of INR 1,50,000 under Section 80C while providing equity returns.

Still, the investor must be well-versed in the various categories of equity mutual funds, as each fund has unique characteristics, risks, and rewards.

It is advisable to consult with your investment advisor, who can help you choose an equity mutual fund that aligns with your investment horizon and financial goals.

Frequently Asked Questions (FAQs)