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All about Equity-oriented Mutual Funds

Before getting to know what equity funds are, let’s first know what mutual funds are.

A mutual fund is a company that collects money from investors and invests that amount in securities such as stocks, bonds, and short-term money market instruments. All the holdings of the mutual fund together are known as its portfolio which is managed by qualified and experienced personnel known as a fund manager. Each security held by the investors by investing in a mutual fund represents their part ownership in the fund and the income generated henceforth.

Likewise, an equity mutual fund scheme invests predominantly in a set of stocks. Depending on the investment objective, the investment strategy of the fund, the fund manager may invest your funds in pooled assets in a category of stocks.

Based on asset classes, mutual fund schemes can be loosely divided into three categories:

1. Equity Schemes - Funds that mainly invest in shares of equity

2. Debt Schemes - Funds that mainly invest in debt securities

3. Hybrid Schemes - Funds loving the versatility of allocating their assets between equity/debt according to the purpose of the scheme

However, the Income Tax Act, 1961, for tax purposes, classifies mutual funds into only two types–equity-oriented mutual funds and non-equity-oriented mutual funds. So, let’s dive into what equity-oriented mutual fund schemes are.

What are Equity-oriented Mutual Funds

Those funds that invest at least 65% of the assets in equity and equity-related instruments are equity-oriented mutual funds. The equity-oriented fund portfolio will, therefore, be skewed in favor of equity investments.

According to the Securities and Exchange Board of India (SEBI) classification guidelines, equity-oriented schemes of mutual funds can be categorized into 11 categories:

Multi-Cap Fund

These funds enjoy the versatility of investing in domestic equities at least 65% through market capitalizations. It can invest through the large cap, mid cap and small cap stocks as such.

Large Cap Fund

These funds need to invest at least 80% of their investments in large-cap companies' equity-related instruments. In terms of full market capitalization, large Cap companies are described as the top 100 firms, measured as an average market cap across all stock exchanges where such stocks are listed. According to the latest list released for the half-year ended 31 December 2018 by the Association of Mutual Funds of India (AMFI), the cut-off for large-cap firms is at the average market cap of Rs. 28,332 crores.

Mid Cap Fund

These funds must invest at least 65% of their investments in mid-cap companies' equity-related instruments. Mid Cap Companies are classified as the companies with full market capitalization ranks 101st to 250th, measured as an average market cap across all stock exchanges where such stocks are listed. The average market cap for mid-cap companies ranges from Rs. 8,590 crores to Rs. 27,944 crores, according to the latest list released by the AMFI for the half-year ended 31 December 2018.

Large & Mid Cap Fund

These funds need to invest at least 35 percent in equity-related large-cap stock instruments and, still, at least 35 percent in equity-related mid-cap stock instruments.

Small Cap Fund

These funds need to invest at least 65% of their investments in small-cap companies' equity-related instruments. Small-Cap companies are classified as companies with full market capitalization at rank 251st and onwards, measured as an average market cap across all stock exchanges where such stocks are listed. According to the latest list released by AMFI for the half-year ended December 31, 2018, the listed companies are all small-cap firms below the average market cap of Rs. 8,519 crores.

Dividend Yield Fund

These funds invest primarily in dividend paying stocks of equity-related securities with a minimum of 65% of their assets.

Value Fund

These funds pursue a value investment strategy in equity-related instruments with at least 65 percent of their investments.

Contra Fund

These funds pursue a contrary investment strategy in equity-related securities with at least 65 percent of their portfolio.

Focused Fund

These funds focus on a portfolio's number of stocks and thus hold up to 30 stocks in the portfolio. In addition, these schemes should clearly outline where the scheme plans to focus on multi-cap, large-cap, mid-cap, and small-cap and further invest at least 65% of its portfolio in equity-related instruments.

Sectoral/Thematic Fund

These funds are intended to capture investment opportunities in a specific sector/theme and therefore need to invest at least 80 percent of their investments in equity-related instruments of a particular sector/theme they focus on.

Equity Linked Savings Scheme (ELSS)

These funds need to invest in equity-related securities at least 80 percent of their assets. In addition, these funds have a 3-year lock-in duration from the investment date and are eligible for tax deduction u/s 80C of the Income Tax Act, 1961.

Benefits of Equity Mutual Fund

Investing in equity mutual funds offers several advantages.

  • Diversification

    Equity Funds invest in a range of securities which lowers the risk if any security fails to perform. If you directly invest in stocks, you may not be able to invest in many securities to add to your portfolio. Thus, an equity mutual fund brings diversification to your investment portfolio and safeguards your investment objective.
  • Professional Management

    Majority of the investors lack the necessary knowledge and skill required to get the best from an investment. By investing in a mutual fund, dedicated skilled professionals are appointed by the mutual fund houses to track the prospects and potential of the companies by continuous research and monitoring.
  • Lower entry level

    Investment in equity mutual funds is possible with as low as Rs. 500, which is especially encouraging for investors interested in taking exposure to the stock market with a small amount of money.
  • Plans & Services by Mutual Fund Houses

    If you invest directly in the stock market, you will be deprived of the innovative plans offered by the mutual fund companies. Investment in equity mutual funds offer automatic re-investment plans, systematic investment plans (SIPs), systematic withdrawal plans (SWPs), asset allocation plans, etc. to help you efficiently manage your portfolio along with sound financial planning.
    Such plans allow investors to easily enter/exit funds, or switch from one fund to another which probably will never be possible with direct investment in stocks.

Types of Equity Mutual Funds

As per the SEBI categorization of mutual fund schemes, equity mutual funds can be classified into 10 different sub-categories.

  • Large-cap Fund – Invests minimum 80% in large-cap stocks.
  • Large & Midcap Fund – Invests minimum 35% in large-cap companies and simultaneously maintain a minimum 35% allocation to mid-cap stocks.
  • Midcap Fund – Invests minimum 65% in mid-cap stocks.
  • Small-cap Fund - Invests minimum 65% in small-cap stocks.
  • Multi-cap Fund - Invests minimum 65% across large cap, mid cap, small cap stocks.
  • Dividend Yield Fund - Invests minimum 65% in dividend yielding stocks.
  • Value/Contra Fund - Invests minimum 65% in equity by following the value/contrarian investment strategy.
  • Focused Fund – This scheme focuses on the number of stocks (maximum 30), and invest a minimum of 65% of its assets in equity & equity related instruments.
  • Sectoral/Thematic Fund - The investment in equity & equity related instruments of a particular sector/particular theme (like banking, FMCG, etc.) should be a minimum of 80% of total assets.
  • ELSS (Equity Linked Savings Scheme) - Invests minimum 80% of total assets in equity & equity related instruments (as per the Equity Linked Saving Scheme, 2005 notified by Ministry of Finance) with a statutory lock-in of 3 years and offer tax benefit under section 80C

Tax Treatment of Equity-Oriented Mutual Fund Schemes

Revenues from mutual fund schemes are taxed in the hands of investors as capital gains. Profits from equity-oriented mutual fund schemes are known as short-term capital gains if the investment in such funds is less than 12 months in duration The gains will be treated as long-term capital gains if the investment is kept for more than 12 months.

Short-term capital gains are taxed at 15% (plus the cessation and surcharge applicable), while long-term capital gains are taxed at 10%. In addition, long-term capital gains from equity-based mutual fund schemes are exempted up to Rs. 1 lakh per year.

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