Equity funds have emerged as a preferred investment choice among investors. These are mutual funds that direct their investments into the stock market. These funds meticulously choose a variety of companies to invest in, aligning with the investment objectives and criteria of different mutual fund schemes.

What makes equity funds attractive is their capacity to generate significant long-term wealth, closely mirroring the performance of the stock market. Investors can choose from the wide range of equity fund options and leverage the growth potential offered by different equity categories, driving their financial progress toward prosperity.

Mutual fund schemes take advantage of equity funds based on their objective, risk profile and the investment window of investors.

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Types of Equity Funds

There are three main types of equity funds. These are:

• Market Capitalizations: These funds are classified based on the size of the companies they invest in. They can be further divided into large-cap funds, mid-cap funds, and small-cap funds, each targeting companies with varying market capitalizations.

• Investment Strategies: Equity funds also vary in their investment strategies, such as growth funds, value funds, and dividend funds. Each strategy focuses on specific criteria for selecting companies and aims to achieve different investment objectives.

• Tax Benefits: Certain equity mutual funds offer tax benefits under specific investment schemes, like Equity-Linked Savings Schemes (ELSS). These funds provide investors with tax deductions under Section 80C of the Income Tax Act under the old regime, making them a popular choice for tax-efficient investing.

Market Capitalization-based Equity Funds

Types of equity mutual funds based on market capitalization are:

• Large Cap Funds: These are funds that invest at least 80% of their assets in stocks of large cap companies (the top 100 companies as far as market capitalization is concerned). These are well-known companies with long-term record of wealth creation. Thus, investors are reasonably assured of safety and growth of their investments.

• Mid Cap Funds: These are equity funds that invest 65% or more of their assets in mid cap stocks (101-250 companies as far as market capitalization is concerned). There is a bit more volatility in these stocks than the large cap funds, but the returns are typically higher.

• Large and Mid-Cap Funds: These are equity funds that invest 35% of their assets each in large as well as mid cap stocks. The remainder is either invested in the same stocks or in various other securities and options permitted by SEBI.

• Small Cap Funds: These funds invest 65% or more of their assets in small cap companies (251 or above in terms of market capitalization). These are usually funds high on volatility, but also capable of delivering higher returns than the large cap or mid cap funds.

• Multi cap funds: This type of equity funds relies on diversification of assets across large, mid and small cap companies to achieve superior returns. These funds need to invest a minimum of 25% of their assets into large/mid/small cap stocks each.

Equity funds classification according to investing styles

Equity mutual funds types based on investing styles are:

• Dividend Yield Funds

  These funds primarily invest in high dividend yielding stocks, with at least 65% in stocks. The dividend yield of a stock is the proportion of the dividend it pays compared to its current market price. Typically, stocks with a high dividend yield are established companies that have steady business models and reliable cash flows.

• Value Funds

  Value funds follow a value investing strategy. This strategy is also referred to as contra investing. Value funds invest in companies that are being traded at a price lower than their true value. In technical terms, this discount is referred to as factor of safety. The fund manager arrives at the true value of a stock by conducting an in-depth analysis of the company. Value stocks are often identified by their comparatively lower price-to-earnings or price-to-book ratios, along with relatively higher dividend yields.

• Focused funds

  Focused funds invest their assets in a maximum of 30 stocks of companies. Focused funds carry significantly more concentration risks as compared to other diversified equity funds because their investment is limited to 30 stocks. Having said that, these funds have the capability of generating superior returns if the fund manager picks the right stocks to invest in.

• Sectoral or Thematic Funds

  These funds follow a specific investment theme such as an emerging market theme, international stock theme or any other theme to invest. Similarly, these funds may also choose to invest in a specific market sector such as health care, pharmaceutical, infrastructure, information technology, banking or any other sector. Sectoral or thematic funds allocate a minimum of 80% of their assets in a particular sector or theme as mentioned above. Since these funds are focused on a particular sector or theme, they tend to carry a higher risk as compared to other diversified equity funds.

Equity funds classification according to Tax Benefits

• Equity-Linked Savings Scheme (ELSS)

  ELSS are popularly referred to as tax-saving mutual funds as these funds allow you to claim a deduction of tax from your total income on the investment amount made in the financial year. This benefit is over and above the tax benefit enjoyed by equity schemes on long-term capital appreciation. By investing in ELSS funds, you become eligible to claim a tax deduction of up to Rs. 1.5 lakh in a financial year under Section 80C of the Income Tax Act under the old regime.

ELSS funds have a mandatory lock-in period of 3 years which restricts you from redeeming the units of these schemes for 3 years from the date of investment.

Due to their predominant investment in large companies, these funds generally carry a lower level of risk and offer moderate potential returns. Additionally, they are comparatively less risky and come with the added advantage of tax benefits on investments.

Benefits of equity fund investments

Portfolio diversification – Equity funds are a great option to diversify one’s portfolio. Instead of directly investing in a specific stock, equity funds enable investors to benefit from the growth of a large number of companies on the stock exchange. Further, the stocks are spread across different industries which leads to greater likelihood of wealth creation.

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Superior inflation adjusted returns – Inflation has been a key concern for investors. This is where equity funds offer better inflation adjusted returns since the latter are directly linked to market performance. Equity funds offer a better growth opportunity in the long term than some other schemes.

As we observed, equity funds are a great option for investors, and one can start an SIP for as low as INR 500 a month which makes equity funds suitable for all investors.
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Mutual Fund investments are subject to market risks, read all scheme related documents carefully.