An Equity Fund is one that mainly invests in the shares of various companies. To be classified as an equity fund the scheme will have to have at least 60% of its total assets in the shares of companies. The remaining amount can be invested in other securities available like Debt securities, money market instruments, etc. as per the objectives of the fund.
Funds are further classified in the equity fund category based on the type of equity shares held. They are done on the basis of market cap i.e. large-cap, mid-cap or small-cap funds. Equity funds can also be sectoral or thematic.
According to AMFI, the Assets Under Management (AUM) have been increased from Rs. 34,000 crores in March 2000 to Rs. 650,000 crores in March 2020. In addition to that equity funds have offered a CAGR of 16% for 2 decades ending March 2020. It is important to note that equity funds are considered to be riskier than debt alternatives available in the markets.
Factors To Consider Before Investing In An Equity Mutual Fund
The factors to consider before investing in an equity fund can be divided into two categories. The first includes drawing your own financial roadmap. The second list of factors helps you select the best funds to meet your needs.
1. What is Your Investment GOAL?
The very first factor to consider when investing in equity funds is understanding what you want to get out of this investment. And then creating a strategy or selecting investment alternatives accordingly. These goals could vary from simply looking for a good savings scheme, tax reduction, saving for a daughter’s marriage, saving for retirement, etc. Once this aim is set it becomes clear about how much time you have in your hands and the returns to expect to meet these goals.
If you have never considered this before it is best to spend a few hours setting your goals and then looking at where you stand financially. Here you can actually calculate your expenses and then arrive at what you can afford to invest.
2. Time Availability
Once your financial goals are set the next step is to set a timeline by which you want these goals to be achieved. This is important as this further will help you select a fund that meets your needs. Say for example you are trying to save up for a vacation down the line.
In this case, investment options like liquid or short-duration funds would best suit your goals. On the other hand Equity, Linked Savings Scheme funds would best suit you if you are saving for your long-term goals as they already have a 3-year lock-in period.
Perfect time to invest?
When investing in funds investors often get carried away by trying to find the most optimal investment price. Although this holds true when investing in stocks. But what’s the point of going for a mutual fund when you also have to compute the optimal period as well.
. What is your Risk Appetite?
The risk appetite varies greatly from individual to individual. Hence there is no single formula that will work for everyone. The risk appetite depends greatly on an individual’s financial condition, age, needs, attitude, etc.
Take for example it wouldn’t be ideal for some in their late 40’s saving for their retirement to put all their savings in a Small Cap Fund which comes with increased risk. On the other hand, it also wouldn’t be optimal for a 20-year-old to put all his savings in a debt fund. Hence it is very important to be realistic and invest in options that suit your goals.
4. Performance of the Fund
At the end of the day, the performance of the fund holds the most leverage when making investing decisions. The performance of the fund gives you an idea of how well your money will be managed in the years to come. If you take a look at the returns offered by the fund you may observe returns of 7%, 8%, 15%, etc.
But how do you determine based on these numbers you are investing in the best fund to meet your goals. The following standards will help you assess this:
a. Comparison with the benchmark
Every fund sets a benchmark index to track and compare their fund. These benchmark indexes track the performance of a collection of top securities in the market. The basis of grouping these securities is done mostly on Mcap. Say for eg. if you consider investing in a large-cap fund. The fund managers will have set a benchmark since the inception of the fund. In this case, the benchmark would most likely be the Nifty50 or the Sensex 30 index.
The logic behind this is the benchmark represents a collection of securities in the market. A comparison with the benchmark would show us if the manager of an actively managed fund is at least able to beat the returns offered by passively investing in the market. If the investment manager is not able to beat this benchmark then it is better to invest in a fund that simply tracks the Nifty 50 and invests in the same securities that exist in the benchmark.
b. Comparison with its peers
The next comparison that an investor can look into before investing is with the other funds in that category. Say you are investing in Large Cap there are many fund houses that provide similar funds. Here one can observe if the fund an investor is considering performing well enough or the best among its peers.
c. Consistency of these performances
Finally, the fund is worth investing in only if it has maintained its results consistently for a period of time. Hence the above comparisons must be done also for 3, 5,10 year periods. The fund consistently beating the benchmark set and performing well among its competitors is a healthy sign of a good fund.
5. Size and Type of the Fund
By size of the fund, we refer to the total assets under management (AUM). The assets under management refer to the subscriptions that the respective fund has received from investors. A fund with a huge AUM shows that it is highly in demand and increased investor trust in the fund. A larger AUM is also seen to be beneficial when it comes to liquidity. Smaller AUM’s are generally seen in newly set up funds.
However, having a large AuM is not always favorable as funds with huge AUM will find it harder to move around in the market.
There are many different types of Equity Funds. Looking into this is important as these funds hold different levels of risk. They may be classified based on the
- Market Capitalization: Large Cap, Medium Cap, Small Cap, Multi-Cap Funds, etc.
- Region: Domestic or Global based on whether the fund invests only in domestic securities or in global markets as well.
- Sectoral: these funds only invest in specific sectors like IT, Pharmaceutical, etc.
- Focused: These funds invest in a maximum of 30 securities.
6. Expense Ratio
Another factor that equity investors must closely look at are the Expense Ratios of funds. The expense ratio includes the administration, management, promotion, and distribution expenses of a mutual fund.
Funds that are actively managed by the fund managers have a higher expense ratio than funds that are passively managed. Also, funds that generate high returns consistently charge higher fees than their counterparts. These expenses however have been capped at 2.25% by the SEBI (Securities and Exchange Board of India).
Generally, the management fee is charged as a percentage of the total AUM. But funds also levy performance fees which are variable depending upon the performance. Since these come out of the returns your capital makes it is best to keep track of them. 2% charged over the long-term compounds to huge amounts!
It is also important to consider the means available for you to invest in an equity fund. Directly investing through the equity fund offers the lowest expenses in comparison to using other intermediaries.
Related:- Why Investing in Stocks is NOT Gambling?
7. Tax Benefits
Different funds have their own unique set of features. ELSS (Equity Linked Savings Scheme) a type of equity fund that offers tax exemption up to Rs. 150,000 from your annual income each financial year under Section 80C of the Income Tax Act, 1961. Hence it is best to look into the tax benefits while investing in a fund.
Taxes also play a role while moving out of a fund. Mutual funds in India levy capital gain taxes at the following rates:
LTCG: 10% (No tax if the amount invested is below Rs.1 lakh and held for more than one year)
STCG: 15% (Applicable on funds invested for less than one year)
8. Experience of the fund manager
Before making any investment decision it is also important to look into the background of the fund manager. An experienced fund manager who has previously also delivered results is more preferred in comparison to other alternatives available. Because at the end of the day it is the managers’ expertise and experience that will help navigate the markets to produce the best returns.
9. AMC’s Background
The Asset Management Company (AMC) or the Fund House is a company that manages these funds. It is important to check how well AMC’s funds have performed in the past and managed its schemes. Examples in India include SBI Mutual Fund, HDFC Mutual Fund, Nippon Mutual Fund, Axis Mutual Fund, Mirae Asset Mutual Fund, ICICI Prudential Mutual Fund, etc.
10. Exit Load and Lock-In
Finding out about the Lock-in period of the Equity funds goes a long way in your financial planning. The Lock-in refers to the period for which the investor is restricted from making redemption of his units from the fund. One example we have seen earlier is ELSSs that have a lock period of 3 years.
Although a part of expenses the Exit Load charges are often overlooked at the time of investing. Exit Loads are charged at the time you exit your fund before a given period.