Equity Funds

An equity mutual fund is an open-ended mutual fund scheme that aims to generate wealth over a long-term period by predominantly investing in equity stocks and equity related instruments. According to SEBI mutual fund regulations, an equity fund scheme should invest at least 65% of its assets in equity related instruments. Equity mutual funds are suitable for investors who are looking for a long-term investment and have a moderate to high-risk appetite.

An equity fund collects money from multiple investors and invests in the equity shares or stocks of different companies. In exchange, the investors are allotted the units of the fund. The price of each unit is known as the Net Asset Value which is the market value of the stocks/shares held by the equity fund scheme. Since the market value of shares changes every day, the NAV of the equity fund also varies on a day-to-day basis.

The specific stocks that an equity fund chooses to invest in depend on two key factors.

The first factor is the category of the fund, which is determined by regulatory guidelines set by the Securities and Exchange Board of India. Equity funds are categorized based on either their investment style or their investing universe. For instance, Large Cap Funds are required to allocate at least 80% of their funds into the top 100 companies in India by market capitalization, which are known as large-cap companies. Similarly, Mid Cap Funds must invest a minimum of 65% of their assets in mid-sized companies in India. The rest of the amount is invested in debt and money market instruments.

Once the fund category is established, the fund needs to determine which specific stocks to include from its designated universe. This is where the expertise of the fund manager and their team becomes crucial. These professionals possess extensive knowledge and experience in financial markets. They conduct thorough research and analysis, considering various factors such as a company's profitability, its resilience during economic downturns, the industry it operates in, and more. Based on this research, they make informed investment decisions, including which stocks to buy, at what price, when to sell, and the quantity to acquire. The fund managers carefully monitor company performance, sector trends, and the economy to determine their influence on stock prices. They remove underperforming stocks and invest in promising companies. This active management allows them to optimize equity mutual funds returns and navigate market volatility successfully.

There are numerous benefits of investing in equity mutual funds. These include:

Long term Wealth Creation
Equity funds have the potential to present a promising opportunity to outpace inflation and accumulate significant wealth over the long term. Historical data demonstrates that equity has consistently been the top-performing asset class. For instance, over the past 20 years, Nifty 50 TRI has delivered an annualized return of 13.25%*. Source: NSE India, Data as on 27 June 2023.

Portfolio diversification
Equity mutual funds offer portfolio diversification by investing in a range of stocks from various industry sectors. By spreading investments, these funds aim to minimize the risks associated with specific stocks or sectors. As a result, even if some stocks in the portfolio underperform, you can still benefit from the capital gains generated by the performance of other stocks in the fund’s investments. This diversification strategy helps mitigate risks and enhances the potential for overall returns.

Easy on pocket
You can do investment in equity funds through the Systematic Investment Plan (SIP) approach. It enables you to make regular investments on a weekly, bi-weekly, monthly, or quarterly basis, with amounts as low as Rs. 500. Besides, SIP in equity mutual funds helps to mitigate the impact of market volatility through rupee-cost averaging.

Professional fund management
Equity mutual funds are managed by professionally experienced fund managers who have expertise in investing in stock markets. They carefully examine the market, assess the performance of different companies, and strategically invest in high-performing stocks that have the potential to generate optimal equity mutual funds returns for investors. You can rely on these seasoned fund managers to effectively manage your investments.

Tax benefit
Equity mutual funds offer significant tax benefits, making them efficient investment options. Long-term capital gains derived from equity funds are tax-free up to Rs 1 lakh in a financial year. Any long-term capital gain exceeding Rs 1 lakh is subject to a 10% tax. Short-term capital gains, on the other hand, are taxed at a rate of 15%.

Investors lacking expertise and time
For individuals interested in taking exposure to the stock market but lacking expertise and time, equity mutual funds provide a solution. Investors who don’t know how to invest in equity funds can entrust their investments to the expertise of experienced fund managers by choosing a reputable fund. These professionals analyze crucial factors such as company profitability, resilience during challenging periods, and industry dynamics, taking care of the investment process on behalf of the investor.

Investors having long-term investment horizon
Investors with long-term (at least 3-5 years) goals like retirement, child future planning, etc. could invest in equity funds. Despite short-term volatility, equity funds have the potential to generate substantial returns over an extended period. Even for investors without specific goals but seeking higher returns, staying invested in equity funds for a minimum of 5 years can prove advantageous.

Investors aiming for tax savings and wealth accumulation
Investors seeking tax savings and long-term wealth growth can consider equity funds. Investors looking to benefit from the taxation on equity funds can consider investing in Equity Linked Saving Schemes (ELSS) funds to save on taxes under Section 80C of the Income Tax Act under the old regime. By investing in ELSS funds, investors can reduce their taxable income by up to Rs. 1.5 lakh while potentially earning attractive returns.

• Large-cap funds: These funds invest minimum 80% of their total assets in equity shares of companies ranked between 1 and 100 in terms of market capitalization. These funds tend to offer more stability.
• Mid-cap funds: These funds invest minimum 65% of their total assets in equity shares of companies ranked between 101 and 250 in terms of market capitalization. These funds tend to offer better returns with moderate risk.
• Small-cap funds: These funds invest minimum 65% of their total assets in equity shares of companies with market capitalization ranking above 250. These funds tend to offer higher returns but with higher volatility.
• Large and mid-cap funds: These funds invest minimum 35% of their total assets in equity shares of mid-cap and large-cap companies each. These funds have the potential for high returns with lower volatility.
• Multi-cap funds: These funds invest minimum 65% of their total assets in equity shares across large-cap, mid-cap, and small-cap companies. These funds offer flexibility based on market conditions

• Dividend Yield Funds: These funds invest in high dividend yield stocks of mature companies. They are considered to be less risky.
• Value Funds: These funds invest in undervalued stocks that have the potential to grow exponentially in the future.
• Focused Funds: These funds invest in a maximum of 30 stocks, offering the potential for superior returns..
• Sectoral or Thematic Funds: These funds invest at least 80% in a specific sector/theme. They are known to carry higher sector-specific risks.

Before making an investment decision, investors must carefully assess their financial goals, investment horizon, and risk appetite. To gain a better understanding, investors are classified in two broad categories:

• First-timers: Often, first-time investors are cautious while investing in equity and equity-related instruments. Some factors that lead to such caution include the need for higher investible capital, more time to regularly monitor their investments, and greater expertise to choose the accurate stocks. To overcome these limitations, first-time investors may opt for equity mutual funds. However, selecting the right fund amongst the large number of available options can still be challenging. Investors must consider their goals, risk appetite, and market conditions before making their investment decisions.
• Seasoned investors: Investors who have been investing for a long time may already be aware of equity funds. Nonetheless, they need to carefully assess various factors to mitigate their investment risks. An understanding about the market conditions is advisable to choose the appropriate schemes and earn higher returns when compared to other funds.

The right equity fund will vary from one investor to another. Here are some considerations that can help investors make the right decision:

• Investment objective and strategy: Every mutual fund scheme has a specific investment objective and strategy. Investors must consider these to ensure it meets their personal requirements before making their decision.
• Personal goals: Investment goals may vary from tax savings to long-term wealth creation and more. Eliminating schemes that do not match investors’ personal goals can help shortlist the right equity fund.
• Risk versus reward: Equity funds deliver higher returns but come with a greater risk. By understanding the fund’s risk profile and investment portfolio, investors can make an informed decision and choose an equity scheme that suits their risk appetite.
• Liquidity: Generally, equity funds are recommended when investment horizon is between medium to long-term. Investors with a shorter investment horizon may not benefit from higher returns and must choose alternative options like debt funds.

Investors can start their investments by either filling and submitting a physical form directly to the asset management company or a registered distributor. At the time of investing, investors must opt between lumpsum and systematic investment plan (SIP) as per their preference. Finally, they can make the payment either via cheque or online based on the option chosen at the time of registration.

Equity mutual funds are taxed as follows:

• Dividend Distribution Tax (DDT): DDT is levied at source. Therefore, the AMC will deduct the applicable DDT rate (currently 10%) at the time of paying the dividends.
• Capital Gains Tax (CGT): Short-term capital gains tax (STCG) is applicable if the investment is held for less than one year. The current STCG rate is 15%
  
  Long-term capital gains tax (LTCG) is levied when investors hold their investments for a period exceeding one year. A 10% LTCG without indexation is applicable for long-term capital gains of more than INR 1 lakh

Before investing in equity funds, investors must consider the following factors:

• Fund objectives: The best funds can help investors accumulate wealth over the long-term. Investors may either choose value investing or growth investing. The former strategy invests the capital in undervalued stocks with the potential to deliver profits. The latter strategy invests the amount in outperforming stocks even if their prices may be higher.
• Fund types: Equity funds can invest in large, mid, or small cap stocks. Mid and small cap stocks have the possibility of offering higher returns but with greater risks. In comparison, large caps significantly reduce the investment risk but may not offer stellar returns. Investors may opt for multi-cap funds that invest across different market capitalization stocks.
• High volatility: All equity funds have certain inherent risks and are impacted by market volatility. Any increase or decrease in the market will impact their NAV and therefore, equity funds are riskier than debt or money market schemes.
• Cost analysis: AMCs charge an expense ratio to cover the professional fund manager’s costs. It is a percentage of the investment and a smaller ratio increases actual returns and vice versa.
• Investment horizon: Equity funds are liable to higher fluctuations in the short-term. Therefore, investors are advised to opt for these schemes only if they have a longer investment horizon.
• Financial goals: Equity schemes deliver higher returns when held for the long-term. Therefore, these are suitable for investors who want to meet long-term financial goals like retirement or wealth creation.

The best equity scheme will depend on an individual investor’s risk appetite, investment horizon, and financial goals. If the objective is tax-savings, ELSS can be an appropriate option. Investors who do not want the lock-in period and aren’t looking to save tax may choose flexi cap or large cap funds. Investors who are willing to assume high risk and invest for at least seven years may opt for mid or small cap funds.