Part Two: Comprehensive Classification of Mutual Fund Schemes and Product Categories

To ensure that investors can clearly distinguish between various investment options, SEBI has mandated a standardized classification for mutual fund schemes based on asset allocation and investment strategies. This part details the different types of open-ended and closed-ended products available in the Indian market.

1. The Five Main Categories of Mutual Funds

SEBI has broadly classified mutual fund schemes into five functional groups to help investors make informed decisions. These are:

1. Equity Schemes
2. Debt Schemes
3. Hybrid Schemes
4. Solution Oriented Schemes
5. Other Schemes (Index Funds, ETFs, and Fund of Funds)

Mutual fund houses are generally permitted to offer only one scheme per category, except for index funds, ETFs, and sectoral or thematic funds.

2. Equity Mutual Fund Schemes

Equity funds primarily invest in a portfolio of equity shares to achieve growth and capital appreciation. They are suitable for investors with a long-term horizon who can withstand short-term market fluctuations.

2.1 Types of Equity Schemes and Asset Allocation

2.2 Environmental, Social, and Governance (ESG) Investing

Mutual funds can launch ESG schemes under the thematic category using strategies such as exclusion, integration, impact investing, or sustainable objectives.

3. Debt Mutual Fund Schemes

Debt funds invest in securities issued by the government, banks, and private companies. Their returns are derived from a combination of interest (coupon) income and price appreciation.

3.1 Understanding Interest Rate Risk in Debt Funds

The market value of a debt security is inversely proportional to market interest rates.

• When interest rates rise, the value of debt instruments falls.
• When interest rates fall, the value of debt instruments rises.
• Maturity Impact: Higher the tenor (duration) of the security, the greater the impact of interest rate changes on its price.

3.2 Key Debt Scheme Categories

• Overnight Fund: Invests in 1-day maturity securities.
• Liquid Fund: Invests in debt and money market instruments with maturity up to 91 days.
• Money Market Fund: Invests in instruments with maturity up to 1 year.
• Corporate Bond Fund: Minimum 80% in AA+ and above rated corporate bonds.
• Credit Risk Fund: Minimum 65% in AA and below rated corporate bonds (excluding AA+).
• Gilt Fund: Minimum 80% in government securities across various maturities.
• Floater Fund: Minimum 65% in floating-rate instruments.

4. Hybrid Mutual Fund Schemes

Hybrid funds create a balanced portfolio by investing in both equity and debt. The risk profile depends on the allocation ratio between these two asset classes.

• Conservative Hybrid Fund: 75% to 90% in debt; 10% to 25% in equity.
• Balanced Hybrid Fund: 40% to 60% in both equity and debt; no arbitrage permitted.
• Aggressive Hybrid Fund: 65% to 80% in equity; 20% to 35% in debt.
• Arbitrage Fund: Minimum 65% in equity; exploits price differences between cash and derivatives markets.
• Dynamic Asset Allocation (Balanced Advantage): Dynamically manages the mix of equity and debt based on market conditions.

5. Specialized and Other Fund Categories

5.1 Solution-Oriented Schemes

These schemes are designed for specific financial goals and include a mandatory lock-in period.

• Retirement Fund: Minimum 5-year lock-in or until retirement age.
• Children’s Fund: Minimum 5-year lock-in or until the child attains the age of majority.

5.2 Passive Funds (Index Funds and ETFs)

Passively managed funds aim to replicate the performance of a specific benchmark index.

• Index Funds: Invest in the same stocks as the index in the same proportion.
• ETFs (Exchange Traded Funds): Traded on stock exchanges like individual stocks; require a demat and broking account.
• Gold and Silver ETFs: Provide electronic exposure to physical gold or silver without storage hassles.
• Tracking Error: The marginal difference between the return of the passive fund and its benchmark index.

5.3 Closed-Ended Schemes

Unlike open-ended funds, these have fixed maturity dates.

• Fixed Maturity Plans (FMP): Invest in debt securities that mature in line with the scheme's tenor.
• Infrastructure Debt Funds (IDF): Invest 90% of the portfolio in infrastructure sector debt; minimum investment of Rs. 1 crore.

6. Key Takeaways and Terms

Key Takeaways

• Standardization: SEBI categories ensure that "Mid Cap" or "Small Cap" means the same thing across all mutual funds.
• ELSS Benefits: Equity Linked Savings Schemes offer tax deductions under Section 80C but come with a 3-year lock-in.
• Duration Sensitivity: Investors seeking low volatility in a rising interest rate environment should prefer short-duration or liquid debt funds.
• Arbitrage Strategy: Realizing the interest element by simultaneously buying in the spot market and selling in the futures market.

Important Terms for Part Two

• Macaulay Duration: A measure of the time an investor takes to get back the money invested in a bond, used to categorize debt funds.
• Tracking Error: The goal of a passive fund is to keep this error as close to zero as possible.
• In-the-money: An arbitrage position where the future price is higher than the spot price, allowing a locked-in gain.
• iNAV (Indicative NAV): The real-time NAV of an ETF disclosed continuously during trading hours on the exchange.