Types of diversified equity funds


Equity linked Savings schemes (ELSS):

These funds are identical to diversified equity schemes, the only difference being that they offer a tax benefit under section 80 C of the Income Tax Act. Under the section the investor can claim a deduction of up to Rs 1 lakh for amounts that are invested in specific approved securities and payments. However, in order to avail of this tax benefit, the investor need to stay invested in ELSS for a period of 3 years from the date of the investment. In case of redemption before 3 years are up, the investor may have to forego the tax benefit and whatever claimed as a deduction, will be taxed.

The 3-year lock-in period gives the fund manager the flexibility to make long-term investment as he can invest a bulk of the corpus in suitable stocks without the fear of having to meet redemption pressures from investors for a period of 3 years. The tax benefit enhances the rate of return of this category type.

The disadvantages are the 3-year lock in period in case of ELSS funds renders these schemes relatively illiquid vis-à-vis plain vanilla diversified equity funds.

Market Capitalization based

Based on their market capitalization, companies that are traded on the bourses can be classified as large caps, mid caps or small caps. Market capitalization (also known as market cap) is equal to the total number of equity shares issued by a company multiplied by the company’s current market price.

You have several equity funds that are lunched with objective of investing in stocks that belong to either only one or two or all three of the stated segments. In other words, at the time of stock selection, the company’s market capitalization is the basic criteria for selection.

Remember, that in the case of funds which can invest in stocks belonging to only a certain segment of market capitalization, the investment strategy is more focused. If the investment strategy proves correct, then the returns generated could surpass those delivered by the vanilla diversified equity funds. However, if the strategy proves to be incorrect, then there are chances of facing not just low returns but also capital erosion.

Theme Based Funds

Theme based funds are fairly similar to sector funds (funds which invest in stocks belonging to only particular sector or industry).The differentiating factor is the level of diversification that they offer. Instead of concentrating on stocks belonging to a single sector / industry, their focus lies on a specific theme and investing in those companies which work on a similar theme. For instance, some theme based schemes invest in only globally competitive Indian companies or multinational corporations operating in India, others invest in only those companies which offer a dividend yield above a certain pre-determined level, and so on.

Opportunity funds

Opportunity funds are basically diversified equity sector or market-cap based funds with a special focus on making the most of opportunities available in the domestic or international markets. For instance, if a mutual fund believes that there is a significant growth opportunity in the infrastructure sector in the country, it can launch an opportunity fund to invest in this area. These are similar to diversified equity funds, the only difference being that the scheme is allowed to cash in on opportunities arising in the markets with change in the economic scenario.

Dynamic asset allocation funds

Dynamic asset allocation funds have the flexibility to invest partly / wholly in equity and/or debt, in line with the limits/ parameters that are pre-determined by the fund house. The main objective of these schemes is to take advantage of the equity market at lower levels, cashing out at high levels then investing the funds in debt / money market instrument and later re-entering equities when the markets undergo a correction.

Contra Funds

Contra funds are equity diversified schemes which follow a ‘value investing’ strategy. This means that the fund manager looks for stocks of companies which are fundamentally sound but their values are currently not recognized by the market. He invests before this value is acknowledged by the market in order to reap significant capital appreciation.

If the investment call proves correct, the returns generated could be very high vis-à-vis diversified equity funds. However, if the fund management team goes wrong in stock selection, you might not only face loss but capital erosion.

The disadvantage of contra funds is the investor is unable to ride the rally on stocks that are currently finding favor with the markets, which a diversified equity fund can do.

It is important that the investor understands the objective of the particular scheme type and gauge if it matches with the requirement before making investment decision. The investor must remember the investing is not for the present but for the future and making the right choices will make good returns and capital appreciation.