HOW DOES A MUTUAL FUND WORK?
A Mutual Fund is a trust that pools the savings of a number of investors who share common financial goal, investments may be in shares, debt securities, money market securities or a combination of these. Those securities are professionally managed on behalf of the unit-holders, and each investor holds a pro-rata share of the portfolio i.e. entitled to any profits when the securities are sold, but subject to any losses in value as well.

The income earned through these investments and the capital appreciation realized are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.

TYPES OF MUTUAL FUND :

EQUITY ORIENTED SCHEMES :
These schemes, also commonly called Growth Schemes, seek to invest a majority of their funds in equities and a small portion in money market instruments. Such schemes have the potential to deliver superior returns over the long term. However, because they invest in equities, these schemes are exposed to fluctuations in value especially in the short term.

Equity schemes are hence not suitable for investors seeking regular income or needing to use their investments in the short-term. They are ideal for investors who have a long-term investment horizon. The NAV prices of equity fund fluctuates with market value of the underlying stock which are influenced by external factors such as social, political as well as economic.

INDEX SCHEMES :
Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc These schemes invest in the securities in the same weight age comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as “tracking error” in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme. There are also exchange traded index funds launched by the mutual funds, which are traded on the stock exchanges.

SECTOR SPECIFIC SCHEMES :
These are the funds/schemes, which invest in the securities of only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. They may also seek advice of an expert.

TAX SAVING SCHEMES :
These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the Government offers tax incentives for investment in specified avenues. e.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth oriented and invest pre-dominantly in equities. Their growth opportunities and risks associated are like any equity-oriented scheme.

INCOME/DEBT ORIENTED SCHEME :
The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.

HYBRID/BALANCED SCHEMES :
These schemes are commonly known as balanced schemes. These schemes invest in both equities as well as debt. By investing in a mix of this nature, balanced schemes seek to attain the objective of income and moderate capital appreciation and are ideal for investors with a conservative, long-term orientation. Balanced Fund and Gift Fund are examples of hybrid schemes.

MONEY MARKET/LIQUID SCHEMES :
These funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.

GILT SCHEMES :
These funds invest exclusively in government securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factors as are the case with income or debt oriented schemes.