Equity fund is a simpler way to get exposure to the equity markets for retail investors.
Broadly there are two type of equity funds :
A) Active managed:
These are the funds which invest in equities by actively selecting stocks based on thorough analysis. The basic premise being investing after research would lead to superior selection and eventually superior returns. The funds are generally benchmarked against an index, however the stock selection is not restricted to the index, which means that the Fund manager may decide to have altogether different stocks or the weights can be different from the index itself. These are called active weights.
Based on the customers and the regulatory requirements, the funds can be either in a Mutual Fund structure or Portfolio management structure or Alternative Investment Funds. Retail investors generally invest in the mutual fund structure given the flexibility and no size cap on minimum investments and hence would focus on that itself.
B) Passive funds:
These funds are based on the premise that markets are efficient and hence, tracking the index would lead to better outcomes for the investors as the costs are low. In these funds, the aim is to minimise tracking error and hence, be as close to the index as possible. The fund tries to mimic the index to the closest possible extent and hence, any change in the weight or index constituent is bought and sold by the fund in the same proportion.
As we discussed earlier active funds are trying for superior returns. Most of these funds deploy different strategies which can be based on different criteria’s.
Size of the companies: These funds decide their investment universe based on the size of the companies. Also the index is based on the same premise. SEBI has given multiple classifications for the funds based on their sizes. Some of the examples are
- Large cap funds: These funds would predominantly invest in large cap stocks, with some flexibility to go out of the large cap. SEBI classifies top 100 market cap companies as large caps and it provides the list of these companies on a regular basis. Benchmark’s are generally Nifty 50. These funds provide the investors with an exposure to the top listed companies in India, with the fund manager through his expertise would try to select better from these stocks.
- Mid cap funds: As the name suggests the investments would be predominantly in the mid sized companies. SEBI classifies companies from 101 to 250 in this category and it publishes the list of these companies on a regular basis. Expectation of these funds is to provide exposure to companies which are in mid tier category and which are expected to grow faster than their larger counterparts.
- Multicap category: These funds can invest across asset classes with a much larger exposure to mid & small caps compared to the large cap funds. This category has somewhat more flexibility than the other fund categories
- Flexi cap funds: These funds provide maximum flexibility to the fund managers as it allows them to go across the market capitalisation range and invest. This fund category provides much more freedom to the fund manager.
For individual investors the risk profile and time span should the criteria to select funds. It is seen with time that the retail investors try to time the market and that has been the biggest reason for the investors to not able to generate market returns. Also, inability of the investor to identify his risk-bearing capacity has been another reason where the investor has to sell when the markets fall. Hence, like any finance companies which does its Asset liability management (ALM) before investing/ giving loans, an individual investor should also look at it.
Generally, large cap funds are said to be less volatile but the expectation is that mid and small cap may generate higher returns over a very long period of time. Sectoral funds tend to have highest volatility and risk but may also generate highest returns if the sector selection has been right.