investing

&
Mutual
funds
SIMPLIFIED
Financial knowledge series
part 7 of 26

how EQUITY Equity funds come in

several forms. Make sure

FUNDs work
you understand what they
are and how they work
before you invest in them

S
ince the last decade, equity mutual funds (MFs) have
been the first choice of people investing for the long
term. However, to get optimum results from investments
in these MFs, it’s important to match one’s objective
with that of the scheme. This means one should carefully
understand a scheme and its nature before investing in it. Here,
we look at how the three popular categories of equity funds—
equity-linked savings scheme (ELSS), sectoral and thematic
funds—differ, and the things to watch out for.
ELSS. Like any diversified equity MF, it routes your investments
into the equity market. However, certain intrinsic features set it
apart from a normal MF: the amount invested in an ELSS gets
tax benefits, and so the funds invested in an ELSS have a lock-in
period of three years.
Investment in ELSS up to `1 lakh,
under Section 80C of the Income
Tax Act, 1961, reduces the gross
total income by an equal amount, If you want to
thereby reducing the tax liability.
Any income in the form of divi-
invest for the
dends received from an ELSS fund long term and
is tax-free in the hands of the
investor. Even the long-term capi- also save taxes,
tal gains arising from the transfer
of such ELSS units is tax-exempt.
ELSS schemes are a
The lock-in feature lends an ele- good bet
ment of stability to ELSS portfolios.
With corporate money kept out,
these schemes do not have to deal with sudden, large-scale
redemptions. As a result, ELSS tends to have a corpus that is
more stable and of an optimum size, which encourages good
fund management. The fund manager can take a medium- to
long-term view on certain stocks, which helps in improving
returns. The 3-year lock-in period inculcates investor discipline.
The performance of an ELSS may vary from that of a diversi-
fied fund, usually due to different management styles and the
market’s rewards for a particular style at a given point in time.
ELSS schemes may have a small- and mid-cap bias. Fund man-
agers may like to take advantage of the 3-year lock-in period to
exploit value stories in various sectors. If your objective is to be
invested for the long term and also save some taxes along the
way, ELSS schemes could be a good bet. Thanks to the equity
exposure, ELSS is one of the few options available for tax benefits
under Section 80C that has the potential to deliver highest infla-
tion-adjusted returns.
Sectoral funds. These schemes invest in a particular industry
or sector to benefit from its growth. For instance, an information
technology (IT) fund would invest only in IT stocks. The fortune
of a sectoral fund depends entirely on the sector it invests in.
Sector funds are the riskiest funds in the equity funds space as
their fortunes hinge on the performance of a particular sector.
They outperform the broader market in good times, but fall
faster during unfavourable periods. Go for these only if you are
confident of a sector’s future performance.
Thematic funds. These schemes invest in stocks of companies
with a specific theme, such as the rural
economy, infrastructure, real estate,
financial services, and so on. They
choose their investments around an idea
that can span several sectors. Here, the
risk element is not as concentrated as
that in a sectoral fund, but more con-
centrated than in a diversified equity
fund. For example, an infrastructure
fund is a thematic fund that could invest
in metals, construction, roadways and a
range of sectors it believes will benefit
from higher government spending.
Thematic and sectoral funds are for
investors who have a diversified portfolio and are willing to allo-
cate a small portion for higher returns. Such investors should
actively manage their portfolios, track sector performance and
take decisions on entry and exit.
Sector funds are suitable for investors who have knowledge
about a sector, and about whose future performance they are
convinced. These schemes should not be looked at as complete
investment solutions as they can give a tremendous boost to
returns, but the fall can be equally swift. There could be periods
when sector-specific funds do well, but over the long term,
chances of outperformance are more with diversified funds.;
editor@outlookmoney.com
Next issue: debt funds
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