An equity fund is a mutual fund scheme that invests predominantly in equity stocks. In the Indian context, as per current SEBI Mutual Fund Regulations, an equity mutual fund scheme must invest at least 65% of the scheme’s assets in equities and equity related instruments.
There are different types of equity mutual fund schemes and each offers a different type of underlying portfolio that have different levels of market risk.
Large Cap Funds
Large caps are typically defined as companies with market caps that are INR 10k crores or above. These are stocks of usually large and well-established companies that have a strong market presence and are generally considered as safe investments. One important fact about large caps is that information regarding these companies is readily available in newspapers and magazines. Most of the large cap companies have good disclosures and therefore there is no dearth of information for an investor looking into them.
Large companies such as Infosys, TCS, and Wipro are classified as large cap stocks. These companies have been around in the industry long enough and have firmly established themselves as leading players. Their stocks are publicly traded and have large market capitalisations.
Large-cap funds tend to hold up better in recessions, but they also tend to underperform small-cap funds when the economy emerges from a recession. Large-cap funds tend to be less volatile than mid-cap and small-cap funds and are therefore considered less risky.
Mid Cap Funds
Mid caps lie between large cap stocks and small cap stocks. Mid cap stocks are those that generally have a market capitalisation within the range of INR 500 crores and INR 10k crores. These represent mid-sized companies that are relatively more risky than large cap as investment options, yet they are not considered as risky as small cap companies. They rank between the two extremes on all the important parameters like size, revenues, employee and client base.
When one invests in mid caps for the long term, he may be investing in companies that could become tomorrow’s runaway success stories. Generally speaking, mid-cap stocks as an investment can bring you higher returns in 3 to 5 years as opposed to their big brother large cap stocks that can bring you moderate (yet safer) returns during this time frame.
Small Cap Funds
Small caps are typically defined as companies with market caps that are less than INR 100 crores. Many small caps are young companies with significant growth potential. However, the risk of failure is greater with small-cap funds than with large-cap and mid-cap funds.
As a result, small-cap funds tend to be the more volatile (and therefore riskier) than large-cap and mid-cap funds. Historically, small-cap funds have typically under performed large-cap funds during recessions but have outperformed large-cap funds as the economy has emerged from recessions.
Tax-savings funds (ELSS funds)
Tax-savings funds or better known as ELSS funds (Equity Linked Savings Schemes) comes with a lock-in of three years, and qualifies for deduction up-to INR 2 lakh under Section 80C of the Income Tax Act, in the year of investment. They function like any other mutual funds.
The amount you invest in ELSS is deducted from your taxable income, which helps you lower the amount of income tax you are liable to pay. Investments in ELSS are subject to a three-year lock-in period and the returns from the scheme, i.e. dividends and capital gains, are tax-free.
Diversified Equity Funds (Multi Cap Equity Funds)
They invest in stocks of companies across the stock market regardless of size and sector. These funds provide the benefit of diversification by investing in companies spread across sectors and market capitalisation. They are generally meant for investors who seek exposure across the market and do not want to be restricted to any particular sector. They invest in companies across different market caps and hence reduce the amount of risk in the fund. Diversification helps prevent events that could affect a single sector for affecting the fund, and hence reduce risk.
It is ideal for the investor who are seeking returns above Large Cap funds over a long-term Horizon. i.e. 5 years or more. Diversified Funds invest in Large cap as well as mid and small caps. The proportion may vary as per funds strategy.
Thematic Equity Funds
These funds invest in securities of specific sectors such as Information Technology (IT), Banking, Service and pharma sector etc., which is specified in their scheme information documents. So, the performance of these schemes depends on the performance of the respective sector. These funds may give higher returns, but they also come with increased risks.