Equity Funds In India: A Guide To Investing

Equity funds are a type of mutual fund that invests in the stock market. They are managed by fund managers who select stocks to deliver maximum returns while keeping the risk under control. In India, equity funds can be invested in through mutual funds, exchange-traded funds (ETFs), or private equity funds. When choosing an equity fund, investors should consider the cost, performance, risk-adjusted returns, and volatility of the fund. Additionally, it is important to diversify your portfolio and ensure that you have the right fund manager in place. Investing in equity funds carries a certain level of risk, and it is recommended to stay invested for at least five years to minimise this risk and generate better returns.

Know your investor personality

Before investing in equity funds, it is important to understand your investor personality. This involves evaluating your financial goals, risk tolerance, and investment horizon. Here are some key considerations to help you know your investor personality:

Financial Goals

Determine your financial objectives for investing in equity funds. Are you saving for retirement, funding your child's education, or pursuing capital appreciation? Clearly defining your financial goals will help you choose the right investment strategies and products.

Risk Tolerance

Assess your risk tolerance, which refers to the amount of risk you are comfortable taking in exchange for potential returns. Equity funds can fluctuate in value and carry different levels of risk. Some funds focus on established companies with a strong track record, while others invest in emerging startups with higher growth potential but greater uncertainty. Consider your ability to withstand market volatility and potential losses when determining your risk tolerance.

Investment Horizon

Consider your investment horizon, or how long you plan to stay invested in equity funds. Equity funds are typically recommended for long-term investment goals. They can experience short-term ups and downs, so it's important to have a time horizon of at least five years to ride out market fluctuations. If you may need access to your funds in the short term, consider more liquid and stable investment options.

Investment Knowledge and Experience

Evaluate your knowledge and experience in investing. Investing in equity funds requires understanding financial markets, analyzing companies, and making informed decisions. If you are a beginner, consider seeking advice from financial advisors or relying on the expertise of fund managers who actively manage equity funds. More experienced investors may opt for a more hands-on approach, carefully selecting individual stocks or sectors to invest in.

Investment Amount

Determine the amount of money you are willing and able to invest in equity funds. Different funds have varying minimum investment requirements. Additionally, consider the impact of fees and expenses associated with investing in equity funds, such as expense ratios, management fees, and potential exit loads. Ensure that you have sufficient funds to meet the minimum investment requirements and cover any associated costs.

Tax Implications

Understand the tax implications of investing in equity funds. In India, capital gains from the sale of equity funds are taxed, and dividends received may also be subject to taxation. Consider consulting a tax advisor to understand how investing in equity funds aligns with your overall tax strategy and financial goals.

By considering these factors, you can gain a clearer understanding of your investor personality. This knowledge will help you make informed decisions about investing in equity funds, ensuring that your investments align with your financial goals, risk tolerance, and time horizon.

Understand the risks

Equity funds are a type of mutual fund that invests in the stock market. They are managed by fund managers who are professionals with expertise in markets and finance. While equity funds can be a great way to diversify your portfolio and generate good returns, there are also several risks associated with them. Here are some key points to understand about the risks involved in investing in equity funds in India:

Market Risk

Equity funds invest primarily in the stock market, which is subject to market fluctuations. The prices of stocks can change on a daily basis, and assuming you will make a definite return based on the stock price of companies in your mutual fund portfolio is unreasonable. It is important to view your investment as a holistic one that will result in gains over a longer period. The stock market has experienced highs and lows, and it is impossible to predict how long the lows will last or how long it will take the market to recover. Therefore, investing in equity funds is best for those with a moderate timeline for investing, usually at least five years.

Liquidity Risk

Trading volumes and settlement periods can restrict the liquidity of investments made in equities. While rare, there may be instances when mutual funds are unable to sell shares due to extended settlement periods, which can lead to losses.

Capital Risk

There is a possibility of complete failure of the company in which the equity fund has invested, which can result in a loss of capital investment. This risk is higher for private equity funds, which invest in companies that are not listed on the stock market.

Operational Risk

This risk is associated with inadequate processes and support structures within the company in which the investment is made. It is important to assess the growth prospects and potential for generating profits before investing.

Risk of Loss of Principal

If the equity fund portfolio is not curated properly and the majority of the stocks perform poorly, there is a risk of losing your principal investment.

Sector-Specific Risk

Sometimes, due to unexpected reasons, the price of a particular sector may fall. Diversifying your portfolio across different sectors can help mitigate this risk.

Short-Term Volatility

Equity funds can be volatile in the short term, and it is recommended to stay invested for at least five years to ride out the ups and downs.

Research different types of equity funds

Equity funds are a type of mutual fund that invests in the stock market. They are considered riskier than other types of mutual funds but also offer the potential for higher rewards. There are several types of equity funds, and they can be differentiated based on their investment objective and strategy. Here are some of the most common types of equity funds in India:

• Large-Cap Equity Funds: These funds invest in companies with large market capitalisations, typically over INR 20,000 crore or the top 100 companies in a market. They are considered less risky than other types of equity funds and are suitable for investors with a low-risk appetite. Examples of large-cap funds include the Reliance Top 200 Fund and the Aditya Birla Sun Life Top 100 Fund.
• Mid-Cap Equity Funds: These funds invest in companies with medium market capitalisations, usually between INR 2000 and 10,000 crore. They offer higher growth potential and returns than large-cap funds but are also riskier. Mid-cap funds are suitable for investors with a moderate risk appetite. Examples include the Mirae Asset Emerging Blue-chip and the HDFC Mid-Cap Opportunities Fund.
• Small-Cap Equity Funds: These funds invest in companies with small market capitalisations, typically less than INR 5000 or 2000 crore. They are considered the riskiest type of equity fund but offer the potential for high returns. Small-cap funds are suitable for investors with a high-risk appetite and a good understanding of the stock market. Examples include the Kotak Emerging Equity Scheme and the Canara Robeco Emerging Equities fund.
• Sector or Thematic Equity Funds: These funds invest in stocks of companies in a specific sector or theme, such as banking, pharmaceuticals, infrastructure, or travel. They are riskier than diversified funds but can provide high returns if the particular sector or theme performs well. Examples include the L&T Infrastructure Fund and the UTI Transportation and Logistics Fund.
• Multi-Cap or Diversified Equity Funds: These funds invest across different segments of companies, including small, mid, and large-cap. They are suitable for first-time investors as they provide good returns with average risk. Examples include the Mirae Asset India Equity Growth Fund and the SBI BlueChip Growth Fund.
• ELSS (Equity Linked Savings Scheme): ELSS funds offer tax savings to investors, allowing them to save up to INR 1.5 lakh on their taxable income annually. They have a lock-in period of 3 years and are suitable for investors looking for both tax savings and long-term wealth creation. Examples include the Reliance Tax Saver (ELSS) Fund and the Aditya Birla Sun Life Tax Relief 96 fund.
• Contra Funds: These funds invest in companies that are not performing well, going against the market trends. They are backed by speculations and the fund manager's experience. Examples include the SBI Contra Fund.
• Index Funds: These funds are designed to replicate the performance of a specific market index, such as the Nifty or Sensex. They provide lower turnover and expense ratios and are suitable for investors seeking a safer investment option. Examples include the ICICI Prudential Nifty Next 50 Index Fund and the HDFC Index Fund - Sensex Plus Plan.

When choosing an equity fund, it is important to consider factors such as your risk tolerance, investment goals, and time horizon. Additionally, comparing expense ratios and benchmark index performance can help you select the most suitable fund for your needs.

Choose a fund that suits your goals

When choosing an equity mutual fund, investors need to consider the cost they are willing to pay, its performance over time, its risk-adjusted returns, and the volatility of the fund.

Firstly, investors should shortlist peers to compare the mutual fund performance on two key metrics: the expense ratio and the benchmark index. The expense ratio is the annual fee paid to cover the operating expense of a mutual fund or an ETF, including the management, administrative, marketing, and advertising costs borne by the asset management company. As a general rule, investors should select mutual funds that charge a reasonable expense ratio to ensure the majority of their investment is used to generate returns. The Securities and Exchange Board of India (SEBI) has capped the expense ratio to a maximum of 2.5% for equity mutual funds.

Secondly, a benchmark index is used to evaluate the performance of an investment in the stock market. When choosing a mutual fund, investors need to evaluate how the fund has performed in comparison to its benchmark index. A mutual fund that has outperformed the benchmark index is preferred over a fund that has underperformed.

Additionally, investors should consider the following factors:

• Time frame: Understand the time frame for which the money needs to be invested and choose a fund that aligns with your investment horizon. Some funds are better for long-term investments, while others may be suitable for quick returns.
• Risk tolerance: Consider your risk tolerance and whether you are comfortable with speculation. Some funds invest in companies that are doing well, while others speculate on future performance. While speculation may lead to higher returns, it also comes with higher risk.
• Exit load: Some funds charge a fee known as the exit load if you redeem your investment prematurely. This should be considered when choosing a fund to avoid eating into your gains.
• Tax benefits: Consider the tax implications of investing in equity mutual funds, such as tax rebates or deductions available under certain sections of the Income Tax Act.
• Portfolio diversification: Diversification is important to balance out the performance of different stocks in your portfolio. Choose funds that invest across different sectors and companies of varying market capitalizations.
• Fund management: The success of a mutual fund also depends on the expertise and experience of the fund manager. Research the track record and performance of the fund managers to assess their ability to make sound investment decisions.

Diversify your portfolio

Diversifying your portfolio is a crucial aspect of investing in equity funds in India. Here are some essential points to consider:

Understanding Diversification

Diversification is a risk management strategy that involves investing in a variety of assets or securities to reduce the impact of any single negative event. By spreading your investments across different areas, you can lower the risk of losing money. This is especially important when investing in equity funds, as the stock market can be volatile.

Types of Diversification

There are several ways to diversify your portfolio:

• Industry Diversification: Invest in a range of sectors and industries to reduce the impact of industry-specific risks. For example, investing in technology, healthcare, financials, and consumer staples sectors.
• Market Capitalization Diversification: Invest in a mix of large-cap, mid-cap, and small-cap companies. Large-cap companies are well-established and tend to be more stable, while small-cap and mid-cap companies may offer higher growth potential but with greater risk.
• Geographic Diversification: Consider investing in companies based in different regions of India or even internationally. This can help reduce the impact of region-specific economic downturns or regulatory changes.
• Time Diversification: Invest in a mix of short-term and long-term equity funds. Short-term funds may offer more liquidity, while long-term funds are typically held for a minimum of 5 years and are designed to ride out short-term market fluctuations.

Benefits of Diversification

Diversification offers several advantages:

• Reduced Risk: By spreading your investments, you lower the chances of losing a significant portion of your portfolio value due to a single event.
• Improved Risk-adjusted Returns: A well-diversified portfolio can provide more consistent returns over time, as it is less exposed to specific risks.
• Long-term Stability: Diversification helps smooth out the ups and downs of the market. While some investments may perform poorly, others may perform well, balancing out the overall returns.
• Opportunities for Growth: By investing in a variety of areas, you increase your chances of benefiting from the growth of different sectors or companies.

Best Practices for Diversification

When diversifying your portfolio, keep the following in mind:

• Regular Review: Periodically review and rebalance your portfolio to ensure it aligns with your investment goals and risk tolerance. The weightings of different investments within your portfolio can shift over time due to varying performance.
• Avoid Overdiversification: While diversification is important, overdiversification can dilute the potential returns of your portfolio. Aim for a balanced approach that provides adequate diversification without spreading your investments too thinly.
• Consider Expert Advice: Consult a financial advisor or a mutual fund distributor registered with the Association of Mutual Funds in India (AMFI) to guide you in constructing a diversified portfolio that suits your specific needs and goals.

Frequently asked questions