Equity mutual funds are a category of mutual funds which invest predominantly in stocks & shares. They are of various kinds, consequently are classified and sub-classified in various ways. For the average retail investor, equity funds are synonymous with mutual funds.
With increasing popularity and retail participation, it is imperative that the prospective investor is able to select the right funds and appreciate the inherent risks. Past performance of funds, peer advice, media recommendations often influence the choice of funds. To select the “Right Funds”, it is best to know and appreciate the basics.
Equity Mutual funds at the very macro level may be categorised in two broad categories. Passively Managed funds and Actively Managed funds.
Passively managed equity funds follow a particular equity index, e.g. Sensex, Nifty, Nifty midcap 150 etc. These fund invests in the same securities as are in the underlying index and also in the same proportion as in the index. The performance of the fund thus is supposed to mirror the performance of the respective index. These funds have a low expense ratio, and the role of the fund manager is limited.
Actively Managed equity funds on the other hand are fund manager driven. The fund management team based on their expertise and the scheme mandate picks individual shares for the fund. The performance of the fund depends a lot on the fund manager & team. Expenses are higher than their passively managed counterparts. Each actively managed fund has a benchmark index with which its performance is evaluated.
The regulator (SEBI), however classifies only the actively managed funds as equity funds and lists the passively managed funds under “Other Funds”.
SEBI classifies the actively managed funds in eleven separate sub-categories. Each category has a separate investment mandate, inherent risk and potential returns. The investor based on his/her risk appetite, investment horizon and expected returns selects the category. Once the “right category” is identified, only then one should attempt scheme selection from within the category.
If you are satisfied with the returns of an Index, you may go with a passively managed index fund. If however you wish higher returns than the respective index and you are investing for the long term, you may consider an actively managed fund. While selecting your favourite scheme, portfolio of the scheme, fund manager’s performance, AMC reputation need to be considered. Past performance of the scheme may also be referred.
Do appreciate equity is a volatile asset class. Here, potential returns and associated risks go hand-in-hand. Before you invest in any equity fund check your investment horizon and risk appetite. Do remember ratings & rankings are dynamic and may change annually……so might media recommendations. Past performances though often quoted are at best indicative. Understand the category and then proceed to choose your favourite scheme within the category. Your portfolio need not consider all the listed categories, infact some like sector funds are best handled by sector experts and are usually tactical calls.
Disclaimer: Sudipta Sengupta is an Insurance & Mutual Fund Distributor, not an investment advisor and is only authorised to execute your recommendations.