Equity Mutual Funds

Equity Oriented Mutual Funds

Equity-oriented Mutual Fund, or Equity Funds are those that invest at least 65% of its corpus in equity and equity related instruments, as per section 10(23D) of the Income Tax Act. The objective of equity funds is to provide an alternative to investors who are willing to take exposure in the equity markets for higher returns, but do not have the expertise to study stocks and make an informed decision by themselves. This task is therefore performed by fund managers who rely on their financial expertise and market knowledge to allocate the Assets Under Management (AUM) or the fund corpus into equity markets. This corpus is divided into units and sold to investors, who are then able to gain exposure to a diversified basket of equities even after investing small sums of money. This is more efficient than diversifying one’s portfolio of money by individually investing in stocks.

Over the past few years, equity funds have become increasingly popular due to attractive returns and increase in investors’ awareness. Millennials have shifted gaze from traditional FDs and Fixed Income securities, and are willing to take on added risk to gain higher returns. There are over 6 crore retail investors in Mutual Funds in India, out of which 1.5 crores were added just last year! However, it is important to understand the basics of equity mutual funds before investing in them, rather than simply following the herd. Below are some of the basic concepts of equity funds explained.

What to look for before investing in Equity Mutual Funds?

There are various parameters you can look at before deciding to invest in an equity fund;

• Performance: Look at the 1-year, 3-year and 5-year returns of the fund and compare it with the index performance and with other funds.

• Risk: Look at risk measures such as the Sharpe ratio and Standard deviation. Higher ratios translate to higher risk, and hence choose a fund with good returns and lower risk ratio at the same time.

• Performance during downturns: Check how the fund has performed during market slumps. If the fund has managed to remain stable or generated some returns even in a falling market, it is a good bet.

• Diversified portfolio: The scheme should have a well-diversified portfolio and the top ten stocks should not have a weightage of more than 50% in the fund.

• Expense ratio: This refers to the charges of the fund. An actively managed equity fund comes with the cost of churning (how often the stocks are bought and sold). If the expense ratio is not commensurate with the fund’s performance, then you may choose not to invest in the fund.

• Fund manager and AMC: Since you have trusted the fund manager with your hard-earned money, it is important to know the track record and the experience of the fund manager as well as the AMC handling the fund. Always stick to a reputed fund house with at least 10 years of existence and a fund manager who has a good amount of industry experience.

Which approach is better – investing in stocks or mutual funds?

There are many reasons why, as a retail investor looking for long term returns, one should consider investing in equity funds rather than stocks.

• Mutual funds are more stable: Since mutual funds are not exposed to concentrated risk of a single company or management, the NAV does not get majorly affected by any sharp upturn or downturn in the price of individual stocks.

• Diversification: The most important advantage that mutual funds have to offer over stocks is diversification. An individual cannot diversify his portfolio with his limited funds and knowledge of the market, in the same manner that a fund manager can, with a huge amount of corpus and specialized research teams at his disposal.

• Managed by experienced professionals: Fund managers have decades of industry experience and knowledge of the markets, which a retail investor cannot achieve. They have research teams, contacts with corporates and leaders and an in depth understanding of the functioning of the markets. This expertise is put into the management of the fund which would otherwise not be possible for small retail investors.

• Smaller investment is possible: To invest in 4-5 stocks individually in any acceptable quantity requires a large amount of funds. But with mutual funds you can invest as less as ₹500, while getting exposure to all the stocks in the fund’s portfolio.

• SIP route is possible: You can invest a fixed amount systematically and regularly in mutual funds, just like how you would invest in a recurring deposit. This makes it easier to organize savings and encourages regular investment. This is not possible in individual stocks.