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Classification of Mutual Funds – Functional & Operational

Introduction

Mutual funds are not a "one size fits all" product. They are designed to cater to the diverse needs of millions of investors—ranging from a retired person seeking regular income to a young professional seeking aggressive wealth creation. To meet these varied goals, mutual funds are classified into different categories based on their structure (flexibility to buy/sell) and their investment objective (what they aim to achieve).

1. Classification based on Structure (Operational)

This classification depends on when and how an investor can purchase or redeem units from the fund.

A. Open-Ended Schemes

Definition: These are funds that are open for subscription and redemption throughout the year. The scheme does not have a fixed maturity period.

  • Liquidity: Investors can buy or sell units on any business day at the current Net Asset Value (NAV).
  • Capital Base: The capital is not fixed. It expands when new investors enter and shrinks when investors redeem their units.
  • Market Availability: These units are typically not listed on stock exchanges; transactions happen directly with the AMC.
  • Suitability: Best suited for investors seeking high liquidity and flexibility to invest or withdraw at their convenience.

B. Close-Ended Schemes

Definition: These funds have a fixed maturity period (e.g., 3 years or 5 years) and are open for subscription only during the initial launch period (New Fund Offer or NFO).

  • Liquidity: Investors cannot redeem units directly with the AMC before the maturity date. To provide liquidity, these units are mandatorily listed on stock exchanges (like shares) where they can be traded.
  • Capital Base: The corpus is fixed after the NFO closes. No new capital is added, and no capital is taken out until maturity.
  • Suitability: Suitable for investors who can lock in their money for a fixed tenure, allowing the fund manager to invest in long-term assets without worrying about sudden redemption pressures.

C. Interval Schemes

Definition: These are a hybrid of open-ended and close-ended schemes.

  • Mechanism: The fund is open for subscription and redemption only during specific pre-defined intervals (e.g., the first week of every quarter).
  • During Interval: It operates like an open-ended fund.
  • Outside Interval: It operates like a close-ended fund (no direct entry/exit).
  • Purpose: It combines the stability of close-ended capital with periodic liquidity windows for investors.

2. Classification based on Investment Objective (Functional)

This classification depends on where the money is invested and what goal it aims to achieve.

A. Growth / Equity Oriented Schemes

Objective: To generate capital appreciation (wealth creation) over the medium to long term.

  • Portfolio: Invests primarily (at least 65%) in equity shares of companies.
  • Risk: High risk due to stock market volatility.
  • Return Potential: High potential for returns that can beat inflation.
  • Ideal For: Investors with a long-term horizon (5+ years) willing to take risks for wealth creation.

B. Income / Debt Oriented Schemes

Objective: To provide regular and steady income to investors.

  • Portfolio: Invests in fixed-income securities like Government Bonds, Corporate Debentures, and Commercial Papers.
  • Risk: Low to moderate risk. More stable than equity funds.
  • Return Potential: Moderate returns, generally slightly higher than bank fixed deposits.
  • Ideal For: Retired individuals or conservative investors seeking capital protection and regular income.

C. Balanced / Hybrid Schemes

Objective: To provide a blend of both capital appreciation and income/stability.

  • Portfolio: Invests in a mix of both Equity (for growth) and Debt (for stability).
  • Risk: Moderate risk, sitting between pure equity and pure debt funds.
  • Mechanism: The fund manager rebalances the portfolio to maintain importance asset allocation.
  • Ideal For: Investors looking for "best of both worlds"—growth potential with a cushion against market falls.

D. Money Market / Liquid Schemes

Objective: To provide high liquidity and capital safety for very short-term surplus funds.

  • Portfolio: Invests in highly liquid, short-term instruments like Treasury Bills, Certificates of Deposit (CDs), and CPs with maturity less than 91 days.
  • Risk: Lowest risk among all mutual fund categories.
  • Ideal For: Corporates or individuals parking idle cash for a few days or weeks (alternative to Savings Account).

Comparison: Open-Ended vs Close-Ended vs Interval

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Exam Notes: Writing the Answer

Question: "Classify mutual funds based on their structure and investment objectives." (15 Marks)

Model Answer Structure:

Introduction: Mutual funds are classified to cater to different investor needs regarding liquidity, risk appetite, and financial goals. The two broader classifications are based on Structure (Operational) and Investment Objective (Functional).

1. Based on Structure (Flexibility to Transact):

  • Open-Ended: Available for subscription/redemption continuously. Variable corpus. Liquidity provided by AMC.
  • Close-Ended: Open only during NFO. Fixed maturity (3-5 years). Fixed corpus. Liquidity via stock exchange listing.
  • Interval Funds: Cross between the two. Open for transaction only during specific "transaction windows."

2. Based on Investment Objective (Portfolio Composition):

  • Growth (Equity): Invests in stocks for capital appreciation. High risk, high return. Long term.
  • Income (Debt): Invests in bonds for regular income/stability. Low risk, moderate return.
  • Balanced (Hybrid): Mix of Equity and Debt. Balances growth with safety.
  • Liquid (Money Market): Short-term instruments for capital preservation and high liquidity.

Conclusion: An investor chooses a fund based on these classifications—e.g., an Open-Ended Growth Fund for long-term wealth, or a Close-Ended Income Fund for fixed returns over a specific period.

Summary

  • Structure: Open-ended (buy/sell anytime, most popular), Close-Ended (lock-in till maturity, listed on exchange), Interval (periodic liquidity).
  • Objective: Growth (Equity, Wealth Creation), Income (Debt, Stability), Balanced (Mix), Liquid (Short-term Cash Mgmt).
  • Key Difference: Open-ended funds offer liquidity directly through the AMC, while Close-ended funds offer liquidity through stock market trading.

Quiz Time! 🎯

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