Demystifying Equity Mutual Funds: A Comprehensive Guide

In the vast universe of mutual funds, where over 1500 schemes beckon investors, understanding the nuances of various categories is crucial for building a robust portfolio. Among these, Equity Schemes take center stage, offering a diverse landscape of opportunities for investors seeking exposure to stocks. In this guide, we unravel the intricacies of the Equity category in mutual funds, exploring its subcategories, market cap distinctions, and investment styles.

Equity Schemes form a significant segment of mutual funds, offering investors exposure to a spectrum of equities, including Large Cap, Mid Cap, and Small Cap stocks.

Understanding Mutual Fund Categories

SEBI Classifications:

1. Large Cap Funds: Invest 80% in large-cap stocks, with flexibility in the remaining 20% allocation.
2. Flexicap/Focused: Provide managers the freedom to invest across market caps based on prevailing conditions.
3. Large & Midcap: Mandate a minimum of 35% each in Large Cap and Midcap stocks.
4. Mid Cap & Small Cap: Require a minimum of 65% allocation in the respective market cap.
5. Multicap: Allocate 25% each to Large, Mid, and Small Cap stocks.
6. Dividend Yield, Value, Contra: Operate like Flexicap but lack a SEBI definition for specific stock types.
7. Sectoral/Thematic: Concentrate on specific sectors or themes, demanding a focused approach.
8. ELSS (Equity Linked Saving Scheme): Require an 80% allocation across market caps with a 3-year lock-in.

Considerations:

• Large Cap Funds: Essential for stability; exposure possible through Passive or Flexicap/Focused.
• Flexicap/Focused: Pseudo Large Cap with managerial flexibility.
• Large & Midcap: Balanced allocation in Large Cap and Midcap stocks.
• Mid Cap & Small Cap: Influenced by AUM growth; potential shift to large caps.
• Multicap: Evolving category with a diversified approach.
• Dividend Yield, Value, Contra: Flexible, resembling Flexicaps.
• Sectoral/Thematic: Requires sophisticated timing for stable returns.
• ELSS: Tax advantage with an 80% large-cap focus.

Market Capitalization Defined

In the realm of Equity Schemes, market capitalization plays a pivotal role in categorizing stocks. The three primary categories based on market cap are:

• Large Cap Stocks: The top 100 stocks by market capitalization.
• Mid Cap Stocks: Ranging from 101 to 250 in market capitalization.
• Small Cap Stocks: Stocks ranked 251 and below in market capitalization.

Categories Within Equity Schemes

Equity Schemes further branch out into 12 categories, distinguished by the following factors:

1. Market Cap Focus: Whether the fund invests in Large, Mid, or Small Caps.
2. Investment Style: Reflecting strategies like Value, Contra, Dividend, Thematic, and Sectoral.

Let's explore these categories in detail:

1. Large Cap Funds

• Investment Focus: These funds primarily invest (80%) in large-cap stocks, with the flexibility to allocate the remaining 20% across Large, Mid, Small Caps, or debt instruments.

• Challenges: Since SEBI's definition of the top 100 stocks as large-cap in 2018, fund managers face constraints on flexibility, especially in beating benchmark indices.

• Consideration: Large Cap Funds are crucial for portfolio stability, offering exposure to well-established companies. Investors can gain similar exposure through Passive Funds or Flexicap/Focused categories.

2. Flexicap/Focused

• Investment Style: Fund managers have the freedom to invest across market caps based on prevailing market conditions and their strategic outlook.

• Composition: Flexicap funds can have up to 50 stocks, providing a broader market exposure. In contrast, Focused funds are more concentrated, with a limit of up to 30 stocks.

• Pseudo Large Cap: While these funds have the flexibility to explore various market caps, they often exhibit behavior similar to large-cap funds, providing managerial flexibility.

3. Large & Midcap

• SEBI Requirement: These funds must have a minimum of 35% invested in both Large Cap and Midcap stocks. The remaining 30% can be allocated elsewhere.

• Industry Average: Typically, these funds maintain an allocation of around 60% in Large Cap and 40% in Midcap stocks, providing a balanced approach to market exposure.

4. Mid Cap & Small Cap

• Minimum Allocation: These funds need to invest a minimum of 65% in either Mid Cap or Small Cap stocks. The remaining 35% can be distributed across other market caps or asset classes.

• AUM Influence: As the Assets Under Management (AUM) of these funds increase, there might be a shift in the allocation, potentially leading to more investment in large-cap stocks.

5. Multicap

• Allocation: Multicap funds follow a diversified approach, with 25% allocation each to Large, Mid, and Small Cap stocks. The remaining 25% can be invested elsewhere.

• Evolution: This category is relatively new and aims to provide fund managers with flexibility across market caps. The evolution of Multicap funds will be interesting to observe as fund managers adapt to changing market conditions.

6. Dividend Yield, Value, Contra

• Investment Style: Similar to Flexicap, these funds operate across market caps but lack a SEBI definition for Dividend Yield, Value, or Contra stocks.

• Operational Similarity: Functioning like Flexicaps, these categories offer flexibility to fund managers, allowing them to explore diverse investment opportunities.

7. Sectoral/Thematic

• Focus: These funds concentrate on specific sectors or themes, such as Infrastructure. The allocation (80%) is expected to be within the chosen sector, offering a targeted approach.

• Sophistication Required: Suitable for sophisticated investors who can effectively time entries and exits within specific sectors, potentially providing stable risk-returns.

8. ELSS (Equity Linked Saving Scheme)

• Investment Focus: ELSS funds allocate 80% across market caps, with a predominant focus on large-cap stocks, resembling the Flexicap category.

• Lock-In Period: Investors in ELSS benefit from a lock-in period of 3 years, providing an 80C tax advantage of up to 1.5 lakh.

Summing Up Strategies

• For Large Cap Exposure: Consider Dividend Yield, Value, Contra, ELSS, Flexicap, or Focused.
• Sectoral/Thematic Caution: Unless confident in sector timing, it's advisable to avoid these categories.
• Midcap & Small Cap Allocation: Consider separate funds for better control over exposure.

Conclusion

In conclusion, navigating the landscape of Equity Mutual Funds demands a thoughtful approach. Investors must align their goals, risk tolerance, and preferences with the right category. The key is not just in selecting the best scheme but, more importantly, choosing the category that aligns with one's investment objectives. Diversification across categories can enhance the resilience of an investment portfolio, offering a balanced approach to wealth creation.

As the financial market continues to evolve, understanding these categories provides a solid foundation for investors to make informed decisions and embark on a successful journey in the world of mutual funds.