Equity-oriented mutual funds: What is equity-oriented fund and how does it work?

Mutual funds are one of the most common avenues of investment these days. In a mutual fund, investors who have a common investment objective pool in their investment money in a fund. The fund manager uses the pooled in money for investments in a variety of market instruments or other securities. The investors own a unit of mutual fund. Returns generated from the investment are distributed proportionately amongst the investors after deducting applicable expenses and levies.

A type of mutual fund scheme that invests predominantly in equity stocks is called an equity-oriented fund. As per the regulations of SEBI, an equity mutual fund scheme must invest at least 65 percent of the scheme’s assets in equities and equity-related instruments. The chief objective of these funds is to provide capital appreciation over a medium to long term investment horizon.

These funds are very popular amongst retail investors among various categories of mutual fund products. However, equity-oriented mutual funds are more prone to market volatility as major of the investment is in equity.

 

How does equity oriented fund work?

As stated above, these funds invest at least 60 percent of their assets in equity shares of companies in varying proportions in consonance with the investment objective. The balance amount is invested in debt and money market instruments to provide a corpus for redemption requests and reduce the risk. The type of equity funds can vary large-cap, mid-cap, or small-cap funds or a mixture of market capitalization.

These schemes provide different options to the investors like dividend option, growth, etc and the investment can be either value-oriented or growth-oriented. The investor is free to choose an option depending on their preferences. The equity-oriented mutual fund also allows the investors to change the options at a later date. These schemes work very well for investors who have a long-term outlook and seek appreciation over a period of time.

Investment in an equity-oriented fund can be done by the investor directly through the website of the mutual fund house or through a distributor or agent. The mode of investment can be via SIPs or lump sum investments. The investment corpus is reinvested in a range of equity options across various sectors. The returns from this scheme depend on the performance of these equities. Investors usually aim for a more diversified portfolio that reduces the negative effect of an individual stock's adverse price movement on the overall portfolio and on the share price of the equity fund. The price of the equity fund is determined on the basis of the fund's net asset value (NAV) less than its liabilities.

Equity oriented mutual fund is managed by portfolio managers. This includes the day to day management of the fund and deciding when the equity should be bought or sold, keeping in mind the specific investment objectives. The portfolio manager uses his professional judgment and analytical research to make these decisions.

The management of these funds can be active or passive. In a fund where the portfolio manager actively manages the fund, the ultimate aim is to generate maximum returns for the investors. In return, the fund house levies a small fee which is deducted from the investment. The fees charged by mutual funds are regulated and have to be within certain limits imposed by the Securities and Exchange Board of India (SEBI). In contrast, a passively managed fund simply follows a market index, i.e., in a passive fund. The fund manager remains inactive or passive and does not use its judgment to decide as to which stocks should be bought or sold. The main objective remains to replicate or track the benchmark index of the scheme.

 

Types of equity-oriented mutual fund

There are various types of equity mutual fund schemes which are differentiated on the basis of underlying portfolio and levels of market risk. The common types of equity-oriented mutual funds on the basis of market capitalization are:

Large Cap Equity Funds: These funds invest at least 80 percent of its assets in the shares of large-cap companies that fall within the top 100 companies in terms of total market capitalization. This type of fund offers stable returns over a period of time. However, the quantum of return is lower compared to the small-cap and mid-cap equity funds. However, large-cap funds are usually less volatile compared to mid-cap and small-cap stocks and are therefore considered less risky.

Mid-Cap Equity Funds: These funds invest at least 65 percent of its total assets in mid-cap stocks i.e. stocks which rank from 101st to 250th position in terms of total market capitalization. This fund is riskier than large-cap stocks but less risky than small-cap stocks. The fund provides relatively higher returns when compared to large-cap equity funds. It is best suited for investors who have a huge risk appetite.

Small-Cap Funds: These invest in stocks of smaller-sized companies (stocks of companies with 251st and below ranking in terms of market capitalization). These funds are open-ended. Small-cap funds are more risky and volatile as the investment is in young companies that have growth potential. However, returns from small-cap funds are considerably higher and work well for investors who have a risk appetite.

Multi-Cap Equity Funds or Diversified Equity Funds: These invest at least 65 percent of its assets across the large-cap, mid-cap, and small-cap stocks and other equity-related instruments. Due to this, an investor is exposed to a diversified portfolio spread across sectors and market capitalisation. This fund is best suited for investors who want to explore the market without being restricted to only one sector. Diversification helps to reduce the risk as the returns from the investment are not linked to the performance of one stock alone. If you are looking for higher returns, this is a good option.

 

Benefits of equity-oriented mutual fund

Here are the key benefits of investing in such a fund:

Diversification: Your portfolio can have a diverse range of equity from different sectors. You don’t have to research any of these equities or know about the financial status of these companies as the fund manager takes care of that.

Regulated: SEBI regulates all aspects of these mutual funds. Every fund house needs to disclose its month-end portfolios on their website along with NAVs and periodic expense ratios. This information is also available with investment advisory platforms that provide performance and portfolio analysis of mutual funds. This allows investors to take informed investment decisions.

Systematic Investments: Most of the equity-oriented mutual funds allow the investment to be made through a lump sum investment amount or through a systematic investment plan (SIPs). SIPs ensure that you stick to your investment discipline by investing a fixed amount every month.

Great for first-time investors: Investment in these funds is a top choice of budding investors who do not have much knowledge about the mutual funds market. While there is a certain amount of risk associated with any equity investment, investing in a large-cap or mid-cap will usually deliver high returns.

Professionally managed: The investments made are managed by a fund manager who has the experience and knowledge of how the market functions. The fund manager takes decisions to buy or sell a particular stock and meet the investment objective of the investors.

 

How equity-oriented mutual funds are taxed?

The taxation of a mutual fund is an important aspect that affects the investment decision. Most investors would like to invest in schemes that offer them tax benefits. In the case of mutual funds, a differential rate of taxation applies to investment across various fund categories. The applicable tax rate depends on the type of mutual fund and the holding period.

There are two aspects of the taxation of an equity-oriented mutual fund: dividends and capital gains. Dividend refers to the return generated by a particular fund. A capital gain is a difference between the value at which an investor purchased the units of a mutual fund scheme and the value at which the units were sold or redeemed. There are two types of capital gains tax as per the investment tenure: long term capital gains and short term capital gains.

At present, Dividend Distribution Tax (DDT) at 10 percent is paid on all the dividends from equity mutual funds. The investor's in-hand receipt of the dividend is reduced by the extent of DDT.

The holding period of mutual fund units can either be short-term or long-term. In the case of equity mutual funds, a holding period of 12 months or more is regarded as long-term. So, long-term capital gains tax or LTCG applies to those investments. The present rate of LTCG tax is 10 percent.

Equity funds are regarded as short-term investments if the holding period is less than 12 months. In such a case, short term capital gains tax or STCG is applicable. The present rate of STCG tax is 15 percent.

A Securities Transaction Tax (STT) of 0.001 percent has to be paid on equity-oriented mutual funds at the time of redemption of units. The STT is not paid separately as it is deducted from the mutual fund returns.

Equity Linked Saving Scheme, which is an equity-oriented fund, is the only pure equity investment that offers tax benefits up to INR 1.5 lakh in a financial year under Section 80C of the Income Tax Act, 1961. ELSS which provides long term capital gains above INR 1 lakh is taxed at 10 percent. LTCG over Rs 1 lakh is taxable at the rate of 10 percent without the benefit of indexation. Additionally, the mutual fund has to pay a dividend distribution tax of 10 percent on dividends declared under ELSS resulting in a reduced dividend. However, ELSS has a lock-in period of three years. You cannot redeem your units before the completion of three years.

It is critical for an investor to understand the product completely before making an investment. Any unplanned exists should be made only after considering the tax liability. It is best to resist the temptation of making frequent redemptions without considering the tax implications. If you are unsure about your decision, make sure that you seek the advice of an investment adviser and also explain your investment objective.

 

FAQs

I have just started a job and want to start investing in the mutual funds market. What should be the ideal allocation between debt mutual fund and an equity-oriented mutual fund?

Before making any investment decision, an investor should take into account his risk-taking capacity, age factor, financial position, etc. Different types of mutual fund schemes invest in a different type of securities. So it important to fully read the offer documents to understand the benefits and risks associated with a type of product. It is always advisable to not park all your investment in one type of scheme. Diversification is important but the quantum should be decided as per your investment objectives. If you are a new investor, you can consult a financial expert before taking decisions.

 

I came across a tax-saving equity scheme called ELSS. How much should I invest in ELSS?

The amount of investment in ELSS depends on several factors. You would need to take into account other investments already committed such as PPF, EPF, insurance, etc. You also need to take into account the investment objective and the investment horizon you are looking at. If you are a young investor, you may want to invest up to the limit of INR 1 lakh for getting the tax benefits and not invest in any other instrument. However, if you are an experienced investor, you may want to diversify your investment by investing in a couple of different products.

 

I came across the term load in the offer document. What does it mean?

Load refers to the charge collected by a mutual fund when the units are sold. There are two types of loads: entry load and exit load. Entry load is levied when the investor buys a unit whereas exit load applied when the units are sold by the investor. At present, SEBI has mandated that no entry load can be charged by any mutual fund scheme. The exit load charged is credited to the scheme.

No scheme is allowed to increase the exit load beyond the level mentioned in the offer document. Any change in the load will be only for future investments and not to investments made earlier. If fresh loads are applicable or increased, the mutual funds are required to amend their offer documents so that the new investors are aware of loads at the time of investments.

The investors should take the loads into consideration while making the investment as these affect their returns.

 

What is an application supported by blocked amounts?

ASBA is a facility provided by banks to investors in new fund offers (NFOs) of mutual funds. If you apply for an NFO via ASBA, the application amount gets blocked in your bank account. While the amount stays in your account, it cannot be used until you are allotted the unit of a mutual fund.

 

Do any equity mutual funds provide guaranteed returns?

There are no guaranteed returns for equity mutual fund investments. As the investment amount for an equity-oriented mutual fund is invested in equity, it always remains subject to market volatility. It is important to read the offer document thoroughly to understand the risks of a mutual fund scheme.