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Classification of mutual funds

Classification of Mutual Funds

Mutual funds can be categorized based on various factors, primarily their structure and investment objectives. Here's a breakdown of these classifications:

1. Classification Based on Structure

Mutual funds are broadly classified into three types based on their structure:

  1. Open-Ended Schemes
  2. Close-Ended Schemes
  3. Interval Schemes

Let's explore each of these in detail:

a) Open-Ended Schemes

  • Key Feature: Liquidity - These schemes are characterized by their continuous availability for subscription and redemption.
  • Daily Transactions: The mutual fund announces daily purchase and sale prices (NAV) of the units.
  • Purchase: Investors can buy units at the sale price prevailing on any given day.
  • Redemption: Investors can sell (redeem) their units back to the fund at the purchase price (NAV) announced by the mutual fund on that particular day. This feature provides excellent liquidity to investors.
  • No Limit on Fund Size: There is no restriction on the number of units the fund can issue or the amount of money it can manage. Investors can invest as and when they like.
  • Pricing based on Net Asset Value (NAV): The purchase and sale prices are typically based on the Net Asset Value (NAV).
    • NAV Calculation: NAV is calculated by dividing the total market value of the fund's assets by the total number of outstanding units.
  • Availability: Open-ended funds are available for subscription throughout the year and do not have a fixed maturity date.

In essence, open-ended funds offer investors the convenience of buying or selling units at any time based on the current market value (NAV).

b) Close-Ended Schemes

  • Limited Liquidity: Unlike open-ended funds, close-ended schemes do not offer a continuous repurchase facility.
  • Fixed Fund Size: These funds have a fixed fund size in terms of capital and the number of shares issued. No fresh units are created after the initial offer period.
  • No Redemption at NAV: Units of close-ended funds are not redeemable directly with the fund at their NAV during their life.
  • Listing on Stock Exchanges: Units are listed on stock exchanges, and investors buy and sell the same like any other securities at the prevailing market price.
  • Fixed Maturity: The scheme has a specific lifespan (e.g., 5 or 10 years). At the end of this period, the mutual fund liquidates its holdings, and the proceeds are distributed to unit holders.
  • Market Price Fluctuations: The market price of these units on stock exchanges can be above or below their NAV, influenced by market demand and supply.
  • Current Scenario: Close-ended schemes are currently not as popular and their prevalence has significantly declined over the last few years

In summary, close-ended funds have limited liquidity, and investors primarily trade units on stock exchanges, often with prices fluctuating around the NAV.

c) Interval Schemes

  • Hybrid Structure: These schemes combine characteristics of both open-ended and close-ended schemes.
  • Periodic Purchase/Redemption: Interval funds are open for sale and redemption at pre-determined intervals.
  • NAV-Based Pricing: Transactions during these intervals are based on the current NAV.
  • Liquidity at Intervals: They provide liquidity during specific intervals, unlike closed ended which don't provide any liquidity during its tenure.

In short, interval funds provide a balanced approach by offering liquidity at specific periods while also allowing funds to be closed for certain duration.

2. Classification Based on Investment Objectives

Based on their investment objectives, mutual funds can be classified into the following categories:

  1. Growth Funds
  2. Income Funds
  3. Balanced Funds
  4. Money Market Funds
  5. Other Special Schemes

Let's dive into each of these:

a) Growth Funds

  • Objective: To provide capital appreciation (growth in the value of investments) over the medium to long term.
  • Investment Strategy: Primarily invest in equities (stocks).
  • Risk Level: Typically higher risk funds due to their exposure to the stock market.
  • Ideal For: Investors with a long-term investment horizon and a higher risk appetite.

Growth funds are ideal for those who aim for long-term capital appreciation and are willing to tolerate higher market risks.

b) Income Funds

  • Objective: To provide regular and steady income to investors.
  • Investment Strategy: Primarily invest in fixed-income securities, such as bonds, debentures, and government securities.
  • Risk Level: Lower risk than growth funds, focusing on capital stability and consistent returns.
  • Ideal For: Investors seeking regular income with a moderate risk tolerance.

Income funds are best suited for those who prioritize capital stability and regular income streams.

c) Balanced Funds

  • Objective: To provide both growth and regular income.
  • Investment Strategy: Invest in both equities (for growth) and fixed-income securities (for stability) in a predetermined proportion.
  • Risk Level: Moderate risk, balancing potential growth with capital preservation.
  • Ideal For: Investors seeking a balance between growth and regular income with moderate risk tolerance.

Balanced funds suit those who want a combination of income and moderate capital appreciation.

d) Money Market Funds

  • Objective: To provide easy liquidity, capital preservation, and a moderate income.
  • Investment Strategy: Invest in short-term, low-risk instruments such as treasury bills, certificates of deposit, and commercial paper.
  • Risk Level: Very low-risk, aiming for capital preservation and easy liquidity.
  • Ideal For: Corporate and individual investors seeking to park surplus funds for short periods.

Money Market funds are ideal for short-term parking of funds and liquidity management.

e) Other Special Schemes

This category includes specialized mutual fund schemes that focus on specific sectors, themes, or investment strategies, such as:

  • Load Funds: Funds that charge a commission (load) for entry and/or exit.
  • No-Load Funds: Funds that do not charge any commission for entry or exit.
  • Tax Saving Schemes: Funds that offer tax benefits under specific tax laws. Examples: Equity Linked Savings Schemes (ELSS), and Pension Schemes.
  • Industry Specific Schemes: Funds that invest in specific industries or sectors (e.g., IT, Pharma, etc.)
  • Index Schemes: Funds that aim to replicate the performance of a specific market index (e.g., Sensex or Nifty).
  • Sectoral Schemes: Funds that invest in a specified industry or group of industries.

These specialized schemes cater to investors with specific interests, risk tolerance, and investment objectives.

Conclusion

Understanding the different classifications of mutual funds is crucial for investors to make informed decisions aligned with their financial goals, risk appetite, and investment horizon. By carefully evaluating a fund's structure and investment objective, investors can select the most appropriate investment vehicles for their portfolios.

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