Classification of Mutual Funds

This article throws light upon the top five categories for classification of mutual funds. The categories are: 1. According to Ownership 2. According to Scheme of Operation 3. According to Portfolio 4. According to Location 5. Other Types of Mutual Funds.

Category # 1. According to Ownership:

According to ownership, mutual funds in India may be classified as:

(i) Public Sector Mutual Funds and

(ii) Private Sector Mutual Funds.

1. Public Sector Mutual Funds:

Unit Trust of India (UTI) has been functioning in the arena of Mutual- Fund-business in India since 1963-64. However, it was only after 23 years, in 1987 that second fund was established in India by the State Bank of India. Although UTI was functioning successfully, it was found inadequate to meet the requirements of small and medium household sectors.

Thus UTI’s monopoly in mutual fund business was curtailed by the Central Government by opening the operation of Mutual Funds to the requirements of the common investors. SBI-Mutual Fund was the first among all the public-sector commercial banks that started operations during November 1987.

Thereafter a number of public sector organisations like IND Bank-MF, CAN Bank-MF, BOI-MF. PNB-MF, GIC-MF, LIC-MF, etc. have joined in the mutual fund business in a short span of time.

2. Private Sector Mutual Funds:

Seeing the success and growth of Mutual Funds in the Indian capital market, the Government of India allowed the private sector corporate to join the Mutual Fund Industry on February 14, 1992. Since then, a number of private sector companies have approached SEBI for permission to set up private mutual funds.

SEBI (Mutual Funds) Regulations, 1996 provide guidelines for registration, constitution, management and schemes of Mutual Funds.

Thus, the UTI has now to face competition from the banking and insurance in the public sector and various companies in the private sector so far as the mutual funds business is concerned. However, this competition from the private sector is expected to increase the services to the common investors.

Category # 2. According to Scheme of Operation:

The most important classification of mutual funds is on the basis of the scheme of their operations as all types of mutual funds fall under this classification. According to the scheme of operations, the mutual funds could be divided into three categories, i.e. open ended funds, close ended funds and the interval funds.

(i) Open-Ended Schemes/Funds:

Open ended scheme means a scheme of mutual funds which offers units for sale without specifying any duration for redemption. These schemes do not have a fixed maturity and entry to the fund is always open to investors who can subscribe it at any time. Similarly, the investors have an option to get their holdings redeemed at any time. The fund redeems or repurchases the units/shares at periodically announced rates.

These repurchase rates are based upon the net current assets value of the fund. Thus, open ended funds provide better liquidity to the investors. In the same manner, the price at which the units are offered to the public is also announced periodically.

As an investor can directly purchase and sell units under open ended schemes, these are not listed. The Unit Scheme 1964 of UTI, ULIP, Dhanraksha and Dhanvirdhi of LIC Mutual Fund are some of the examples of open ended schemes.

(ii) Close-Ended Schemes/Funds:

A close-ended scheme means any scheme of mutual fund in which the period of maturity of the scheme is specified. Unlike open-ended funds, the corpus of close-ended scheme is fixed and an investor can subscribe directly to the scheme only at the time of intial issue.

After the initial issue is closed, a person can buy or sell the units of the scheme in the secondary market i.e. the stock exchanges where these are listed. The price in the secondary market is determined on the basis of demand and supply and hence could be different from the net assets value.

It is always easier to manage a close-ended scheme as the fund managers can evolve long term investment strategies depending upon the life of the scheme. Dhanshree and Dhansamardhi of LIC Mutual Fund, Canshare of Canara Bank, Ind Jyoti and Swaran Jyoti of Indian Bank are some of the examples of close ended mutual fund schemes.

(iii) Interval Schemes/Funds:

An interval scheme is a scheme of mutual fund which is kept open for a specific interval and after that it operates as a close scheme. Thus, it combines the features of both open ended as well as close-ended schemes.

Interval schemes have been permitted by the SEBI in recent year only. The scheme is open for sale or repurchase at fixed predetermined intervals which are disclosed in the offer document. The units of the scheme are also traded in the stock exchanges.

Category # 3. According to Portfolio:

Mutual Funds can also be classified according to portfolio or the objectives of the fund.

Some of these funds are discussed as follows:

(i) Income Funds:

These funds aim at providing maximum current return/income to the investors. The investments are made in stocks yielding higher returns and capital appreciation is of small importance. Such funds distribute the income earned by them periodically amongst the investors.

There may be income funds of two types; some funds may concentrate on low risk, constant returns while others, may aim at maximum return even at the cost of some risk.

(ii) Growth Funds:

These funds aim at providing capital appreciation in the value of investment. Such funds invest in growth oriented securities have a potential to appreciate in long run. Growth funds concentrate on value appreciation of securities and not on the regularity of income and are also known as ‘Nest eggs’ or ‘Long haul’ investment. However, the risk involved in such funds is higher than the income funds.

(iii) Balanced or Conservative Funds:

Balanced funds spend both on common stock and preferred stock. Some part of funds is spent on buying equity while other part is used in acquiring interest bearing debentures and preference shares ensuring certain amount of dividend. Some funds generally spend half the funds on equity stock while the other half is spent on preferred stock.

Balanced funds ensure both appreciation in stock as well as regular return in the shape of interest and dividend. The investors have advantages of regular income and appreciation in value of securities. These funds are also known as ‘Conservative Funds’ or income and Growth Funds’.

(iv) Stock/Equity Fund:

These funds mainly invest in shares of the companies. The investments may vary from ‘blue chip’ companies to newly established companies. They undertake risk associated with investment in equity shares of companies. Stock funds may have further sub-divisions such as income funds and growth funds. A special type of equity fund is known as ‘index fund’ or ‘never beat market fund’.

(v) Bond Funds:

These funds employ their resources in bonds. These investments ensure fixed and regular income. Sometimes bonds are available in the market at lower than face value, the net income on these bonds goes higher because interest will be received on the face value of the bond. Some companies offer non- convertible bonds along with the shares. Any person subscribing for the shares will have to take up bonds also.

Bonds funds may have a tie up with the companies and offer a certain price if the subscribers want to sell their bonds at the time of allotment. Bond fund will pay a fixed amount to the company and some amount will be paid by the subscriber also.

The shareholder is saved of the botheration of buying bonds compulsorily while the bond fund will pay less than the face value of the bond, thus saving some money. Bond funds ensure regular income to the investors.

(vi) Specialised Funds:

These funds invest in a particular type of securities. The funds may specialize in securities of companies dealing in a particular product, firms in a particular industry or of certain income producing securities. Any investor wanting to invest in a particular security will prefer a fund dealing in suck securities.

(vii) Leverage Funds:

The primary aim of leverage funds is to maximise capital appreciation. These funds may use even borrowed funds for buying speculative stock which ensures a profit in the future. The cost of raising loaned funds and the gain from holding shares is the profit of the leverage fund.

The leverage is used to the benefit of the shareholders. Leverage funds indulge in speculative activities to earn more and more profit. In a declining market the fund may indulge in short sales. The reduced price of the stock in future will benefit the fund. Some other methods may also be used to ensure higher profits.

(viii) Taxation Funds:

Mutual funds may be designed to suit the tax payers. The contributors to such funds get some concession in income tax. The investors are required to keep the money with the fund for a certain period called lockup period which at present is 3 years in India. These funds distribute the profits among the unit holders. A repurchase offer of units is also given at the current net assets value.

A large number of mutual funds have come up with schemes which ensure tax benefits to the subscribers besides some income and small appreciation in value of units. The amount collected by these funds is used to acquire shares and interest bearing securities. The net asset value of the units varies with the values of the securities held. Generally income tax payers contribute in these funds.

(iv) Money Market Mutual Funds (MMMF):

‘Money market mutual fund’ means a scheme of a mutual fund which has been set up with the objective of investing exclusively in money market instruments. These instruments include treasury bills, dated government securities with an unexpired maturity of upto one year, call and notice money, commercial paper, commercial bills accepted by banks and certificates of deposits.

While equities and bonds or debentures dominate the portfolio of ‘Capital market mutual funds’ the money market instruments constitute the only portfolio of ‘money market mutual funds’.

Till recently, only commercial banks and public financial institutions were allowed to set up MMFs. But in November 1995, the Government has permitted private sector mutual funds also to set up money market mutual funds.

Category # 4. According to Location:

Mutual fund can also be classified on the basis of location from where they mobilise funds, as:

(i) Domestic Funds:

These are the funds which mobilise savings of people within the country where investments are made.

(ii) Off-shore Funds:

Off-shore mutual funds are those which raise or mobilise funds in countries other than where investments are to be made. These funds attract foreign savings for investment in India.

Category # 5. Other Types of Mutual Funds:

In addition to the above mentioned mutual funds, there can be some other types of mutual funds also, such as, ‘Loan Funds’ and ‘Non-Loan Funds’ based upon the expenses/fees to be charged; ‘Hub and spoke funds’ which are basically fund of funds, etc.