What are Equity Funds? - Meaning, Types and Benefits

The equity market is one market, but equity funds can take very different routes through it. A fund may seek established companies, combine large, mid and small cap stocks or build its portfolio around a sector, theme or investment style. These differences are not merely about fund names. They determine how a scheme is allowed to construct its portfolio and where an investor's money is deployed. SEBI's categorisation framework defines the investment mandate for different equity fund categories. Knowing the category, its portfolio requirements and the strategy behind it can therefore be a useful first step before investing in an equity mutual fund.

Key Takeaways

• Equity funds differ by category, portfolio mandate, market cap exposure and investment strategy
• Each category has specific portfolio requirements that determine where the scheme can invest
• Equity fund returns are market linked, so NAVs can rise or fall with market movements
• Funds provide diversification across companies and, depending on the category, sectors and market segments
• Equity funds are generally considered for long term investment goals where investors can tolerate volatility
• Before investing, assess the fund category, investment objective, risk, costs and investment horizon

What are Equity Funds?

Equity funds are mutual fund schemes that invest predominantly in shares of companies and other equity related securities. The value of these investments is linked to movements in the equity market, so the fund’s NAV can rise or fall with changes in stock prices. The primary aim of an equity fund is generally to build wealth over the long term through capital appreciation. Depending on its investment mandate, a fund may invest across companies of different sizes, specific sectors or industries or follow a particular investment approach such as value or growth investing. As equity markets can experience substantial price movements over shorter periods, equity funds are generally suited to investors who can tolerate market fluctuations and remain invested for a longer period.

Features of Equity Mutual Funds

Equity mutual funds have specific features related to portfolio structure, diversification, management, market-linked NAV and investment approach. Some of the key features include:

1) Predominantly Equity Oriented Portfolio

Equity mutual funds invest predominantly in equity shares and equity related instruments. The exact allocation and securities selected depend on the category and investment mandate of the scheme.

2) Diversification Across Securities

An equity fund typically invests across multiple companies and depending on its investment mandate, may spread investments across different sectors, industries and market capitalisations. This diversification reduces the portfolio's dependence on the performance of any single company

3) Professional Portfolio Management

The fund manager and investment team research companies, assess their business prospects and valuations and manage the portfolio in line with the scheme's stated investment strategy.

4) Market Linked NAV

The NAV of an equity fund changes with movements in the prices of securities held in the portfolio. Consequently, investors are exposed to both potential gains and losses from equity market movements.

5) Category Specific Investment Mandate

Different equity fund categories have different portfolio requirements. For example, some may focus on large cap companies, while others may invest across market capitalisations, specific sectors or particular investment styles.

6) Long Term Investment Orientation

Equity funds are generally used for longer investment horizons because equity prices can fluctuate considerably over shorter periods. A longer holding period can provide greater opportunity to remain invested through different market cycles, although it does not eliminate market risk.

7) Scheme Level Expenses

The fund incurs costs for investment management and other operations. These expenses are reflected in the scheme's expense ratio and affect the returns earned by investors.

Benefits of Equity Mutual Funds

Equity mutual funds can offer several benefits to investors, depending on the scheme, investment horizon and market conditions. Some of the key benefits include:

1) Potential for Capital Appreciation

Equity funds provide exposure to companies whose earnings and valuations may grow over time. This creates the potential for capital appreciation, although actual returns depend on market and portfolio performance.

2) Diversification Without Direct Stock Selection

Investors can gain exposure to a portfolio of companies through a single mutual fund investment, without having to individually research and purchase each security.

3) Access to Different Market Segments

Depending on the scheme, investors can participate in different segments of the equity market, including large, mid and small-cap companies or specific sectors and investment themes.

4) Professional Research and Monitoring

The investment team continuously evaluates portfolio companies and market developments. This can be useful for investors who do not have the time or expertise to research individual stocks themselves.

5) Systematic Investment Facility

Investors can use SIPs to invest a predetermined amount at regular intervals. This enables disciplined investing without requiring the investor to commit the entire amount at one time.

6) Liquidity in Open Ended Schemes

Open ended equity mutual funds generally allow investors to purchase or redeem units on business days, subject to the scheme's applicable terms, exit load and other conditions.

7) Choice Based on Investment Requirements

The variety of equity fund categories allows investors to select schemes based on their investment objective, risk capacity, preferred market segment and investment horizon.

Types of Equity Mutual Funds

Equity mutual funds are divided into different categories based on their investment mandate, market capitalisation exposure, investment style or portfolio concentration. Under SEBI’s categorisation framework, each category has specified minimum investment requirements.

1) Multi Cap Fund

A Multi Cap Fund must invest at least 75% of its total assets in equity and equity related instruments. Within this allocation, at least 25% each must be invested in large cap, mid cap and small cap companies. This category therefore maintains meaningful exposure to all three market capitalisation segments.

2) Large Cap Fund

A Large Cap Fund must invest at least 80% of its total assets in large-cap companies.

Large cap companies are the top 100 companies by full market capitalisation, based on the applicable SEBI classification. The category therefore focuses primarily on established companies within the large cap segment.

3) Large & Mid Cap Fund

A Large & Mid Cap Fund must invest at least 35% of its total assets in large cap companies and another 35% in mid cap companies. This creates a portfolio with exposure to both large cap and mid cap segments, while allowing the remaining portion to be invested according to the scheme's mandate.

4) Mid Cap Fund

A Mid Cap Fund must invest at least 65% of its total assets in mid cap companies.

Mid cap companies are those ranked 101st to 250th by full market capitalisation under the applicable classification. The category therefore provides focused exposure to this segment.

5) Small Cap Fund

A Small Cap Fund must invest at least 65% of its total assets in small cap companies. Small cap companies are those ranked 251st onwards by full market capitalisation under the applicable classification. The category therefore has a predominantly small cap portfolio.

6) Flexi Cap Fund

A Flexi Cap Fund must invest at least 65% of its total assets in equity and equity-related instruments. Unlike a Multi Cap Fund, it does not have prescribed minimum allocations to large cap, mid cap and small cap companies. The fund manager can therefore change the allocation across these segments according to the scheme's investment strategy.

7) Dividend Yield Fund

A Dividend Yield Fund must invest at least 65% of its total assets in equity and equity related instruments and predominantly invest in dividend yielding stocks. The category is differentiated by its focus on companies that offer dividend yield as an important characteristic of the investment strategy.

8) Value Fund

A Value Fund must invest at least 65% of its total assets in equity and equity related instruments and follow a value investment strategy. The investment approach focuses on identifying companies that the fund manager considers attractive from a value investing perspective.

9) Contra Fund

A Contra Fund must invest at least 65% of its total assets in equity and equity related instruments and follow a contrarian investment strategy. The strategy generally involves taking investment positions that differ from prevailing market sentiment or consensus views, within the scheme's stated mandate.

10) Focused Fund

A Focused Fund must invest at least 65% of its total assets in equity and equity related instruments and can invest in a maximum of 30 stocks. The defining feature of this category is portfolio concentration. Compared with a broadly diversified equity portfolio, the scheme holds a relatively limited number of securities.

11) Sectoral Fund

A Sectoral Fund must invest at least 80% of its total assets in equity and equity related instruments of a particular sector. Because the portfolio is concentrated around one sector, its performance can be significantly affected by developments specific to that sector.

12) Thematic Fund

A Thematic Fund must invest at least 80% of its total assets in equity and equity related instruments related to a particular theme. A theme can span more than one sector. Therefore, thematic funds can have exposure to companies from different industries that are linked to the same underlying theme.

13) ELSS

An Equity Linked Savings Scheme or ELSS, must invest at least 80% of its total assets in equity and equity related instruments, in accordance with the applicable ELSS framework. ELSS also has a statutory three-year lock-in period and specific tax provisions subject to applicable tax laws and conditions. 

Equity Fund Categories at a Glance

How Does an Equity Mutual Fund Work?

An equity mutual fund brings together money from several investors and invests the pooled corpus in equity and equity related securities. Each scheme operates within a defined investment mandate, which determines the type of companies, sectors or investment approach the fund can follow. The process works as follows.

1) Investors Invest in the Scheme

An investor puts money into an equity mutual fund through a lump-sum investment or SIP. The investment is converted into units at the applicable NAV, subject to the relevant cut-off and transaction rules.

2) The Fund Pools Investors' Money

The investments made by different investors form a common corpus. The fund uses this corpus to build a portfolio of securities rather than investing the money separately for each investor.

3) The Fund Manager Builds the Portfolio

The fund manager and investment team select securities based on the scheme's investment objective and mandate.  

4) The Portfolio Value Changes With Market Movements

The market value of the securities held by the scheme changes from day to day. When the value of the underlying investments rises, the value of the portfolio generally increases. When security prices decline, the portfolio value can fall. Dividends or other income received from portfolio securities can also form part of the scheme's returns.

5) NAV Determines the Value of Each Unit

The scheme's assets, after adjusting for liabilities and applicable expenses, determine its NAV. Since the value of the underlying portfolio changes, the NAV also changes. An investor's holding is therefore linked to the number of units owned and the prevailing NAV.

6) Investors Earn Market Linked Returns

Returns are not fixed in an equity mutual fund. An investor's investment value can appreciate or decline depending on the performance of the securities held by the scheme. Over the investment period, returns may arise primarily through changes in the value of the underlying securities and income generated by the portfolio.

7) Investors Can Redeem Their Investment

In an open ended equity mutual fund, investors can generally redeem their units on business days at the applicable NAV, subject to the scheme's terms, exit load and other applicable conditions.

How to Invest in an Equity Mutual Fund?

Investing in an equity mutual fund is a structured process that starts with choosing a suitable scheme and ends with purchasing units at the applicable NAV. A practical approach is to follow these steps:

1) Identify Your Investment Goal

Consider the purpose of the investment, your time horizon and your ability to tolerate market fluctuations. Equity funds are market linked and can experience short term volatility.

2) Choose the Right Fund Category

Select a category based on its investment mandate. Equity funds may focus on large-cap, mid cap or small cap companies, or follow multi cap, flexi cap, sectoral, thematic, value or other strategies.

3) Assess the Scheme

Review the scheme's investment objective, portfolio strategy, asset allocation, risk factors, benchmark, expense ratio, exit load and other relevant terms before investing.

4) Complete KYC

Complete the applicable KYC requirements and provide the necessary investor and bank details.

5) Select the Plan and Option

Choose between the Direct or Regular Plan and the applicable option, such as Growth or IDCW, based on your investment requirements.

6) Choose Lump Sum or SIP

Invest either as a lump sum or through a SIP, subject to the scheme's applicable minimum investment requirements.

7) Make the Investment

Invest through the mutual fund's official platform, an authorised intermediary or another permitted channel. Units are allotted based on the applicable NAV and transaction rules.

8) Review the Investment Periodically

Monitor the scheme against its stated objective and your investment goal rather than reacting solely to short term market movements. Changes to the portfolio or your financial circumstances may warrant a review of the investment.

Invest in Equity Mutual Funds on Kotak Mutual Fund

Investors can invest in equity mutual funds through Kotak Mutual Fund website or app by following a few simple steps:

1. Visit the Kotak Website/App

Go to the official Kotak Mutual Fund website or download the app.

2. Sign Up or Log In

Create an account if you're new, or log in if you're an existing investor.

3. Complete KYC

Submit your KYC details if you're a first-time investor.

4. Choose an Equity Fund

Explore various funds based on your risk profile and goals.

5. Invest

Choose the amount to invest (lump sum or SIP).

6. Track Your Investment

Use the platform to monitor your portfolio's performance.

Why Should You Invest in an Equity Mutual Fund?

Equity mutual funds offer a simple way to participate in the equity market through a professionally managed and diversified portfolio. They can be considered for long term goals where investors can accommodate market fluctuations.

1) Long Term Growth Potential

Equity funds can provide capital appreciation potential by investing in companies that may grow their earnings and business value over time.

2) Built In Diversification

A single fund can provide exposure to multiple companies, sectors and market segments, depending on its investment mandate.

3) Professional Management

Fund managers research, select and monitor securities within the scheme's stated investment strategy.

4) Multiple Investment Choices

Investors can choose from categories focused on market capitalisation, investment style, sectors or themes.

5) SIP Facility

Investors can invest a fixed amount at regular intervals through a SIP, making it easier to build an equity portfolio gradually.

6) Convenient Market Participation

Investors can gain exposure to a portfolio of listed companies without directly researching and managing individual stocks.

7) Liquidity

Open-ended equity funds generally allow investors to redeem units on business days, subject to applicable scheme terms and exit loads.

8) Suitable for Long Term Goals

Equity funds may be relevant for longer term financial goals, while investors should remain prepared for short term market fluctuations.

FAQs

1) What is an equity mutual fund?

An equity mutual fund is a mutual fund scheme that invests predominantly in equity and equity related instruments. Its objective is generally to generate capital appreciation over the long term.

2) Are equity mutual funds risky?

Equity mutual funds are subject to market risk and their NAV can fluctuate with changes in the prices of the underlying securities. The level of risk can vary across fund categories and schemes.

3) Who are equity mutual funds suitable for?

Equity mutual funds may be suitable for investors who have a longer investment horizon and can tolerate fluctuations in the value of their investments. Suitability also depends on the specific fund category and the investor's financial circumstances.

4) Can I invest in equity mutual funds with a low risk appetite?

Equity mutual funds are market linked and can experience significant fluctuations, so they may not be appropriate for investors seeking low volatility. Even categories generally associated with relatively established companies can experience market declines.

5) What is the investment horizon for equity mutual funds?

There is no single investment horizon applicable to all equity funds. Generally, equity funds are considered more appropriate for longer term goals because short term market movements can be significant. The suitable horizon depends on the scheme's strategy, investment objective and the investor's financial goal.

Disclaimers

Investors may consult their Financial Advisors and/or Tax advisors before making any investment decision.

These materials are not intended for distribution to or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation.  The distribution of this document in certain jurisdictions may be restricted or totally prohibited and accordingly, persons who come into possession of this document are required to inform themselves about, and to observe, any such restrictions.

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