| Equity Funds | | | | sectors of the market are known as diversified |
| Equity funds are considered to be the more risky | | | | debt funds. The best feature of diversified debt |
| funds as compared to other fund types, but they | | | | funds is that investments are properly diversified |
| also provide higher returns than other funds. It is | | | | into all sectors, which results in risk reduction. |
| advisable that an investor looking to invest in an | | | | 2) High Yield Debt Funds: As we now understand |
| equity fund should invest for long term i.e. for 3 | | | | thatrisk of default is present in all debt funds, and |
| years or more. There are different types of | | | | therefore, debt funds generally try to minimize |
| equity funds each falling into different risk bracket. | | | | the risk of default by investing in securities issued |
| In the order of decreasing risk level, there are | | | | by only those borrowers who are considered to |
| following types of equity funds: | | | | be of "investment grade". But, High Yield Debt |
| | | | Funds adopt a different strategy and prefer |
| 1. Aggressive Growth Funds: In Aggressive | | | | securities issued by those issuers who are |
| Growth Funds, fund manager aspire for maximum | | | | considered to be of "below investment grade". |
| capital appreciation and invest in less researched | | | | The motive behind adopting this sort of risky |
| shares of speculative nature. Because of these | | | | strategy is to earn higher interest returns from |
| speculative investments Aggressive Growth Funds | | | | these issuers. These funds are more volatile and |
| become more volatile and thus, are prone to | | | | bear higher default risk, although they may earn |
| higher risk than other equity funds. | | | | at times higher returns for investors. |
| 2. Growth Funds - Growth Funds also invest for | | | | 3) Assured Return Funds: Although it is not |
| capital appreciation (with time horizon of 3 to 5 | | | | necessary that a fund will meet its objectives or |
| years) but they are different from Aggressive | | | | provide assured returns to investors, but there |
| Growth Funds in the sense that they invest in | | | | can be funds that come with a lock-in period and |
| companies that are expected to outperform the | | | | offer assurance of annual returns to investors |
| market in the future. Without entirely adopting | | | | during the lock-in period. Any shortfall in returns is |
| speculative strategies, Growth Funds invest in | | | | suffered by the sponsors or the Asset |
| those companies that are expected to post | | | | Management Companies (AMCs). These funds are |
| above average earnings in the future. | | | | generally debt funds and provide investors with a |
| 3. Speciality Funds: Speciality funds have stated | | | | low-risk investment opportunity. However, the |
| criteria for investment and their portfolio | | | | security of investments depends upon the net |
| comprises of only those companies that meet | | | | worth of the guarantor (whose name is specified |
| their criteria. Criteria for some speciality funds | | | | in advance on the offer document). To safeguard |
| could be to invest/not to invest in particular | | | | the interests of investors, SEBI permits only |
| regions/companies. Speciality funds are | | | | those funds to offer assured return schemes |
| concentrated and thus, are comparatively riskier | | | | whose sponsors have adequate net-worth to |
| than diversified funds. These are following types | | | | guarantee returns in the future. In the past, UTI |
| of speciality funds:a) Sector Funds: Equity funds | | | | had offered assured return schemes (i.e. Monthly |
| that invest in a particular sector/industry of the | | | | Income Plans of UTI) that assured specified |
| market are known as Sector Funds. The | | | | returns to investors in the future. UTI was not |
| exposure of these funds is limited to a particular | | | | able to fulfill its promises and faced large shortfalls |
| sector (say Information Technology, Auto, | | | | in returns. Eventually, government had to |
| Banking, Pharmaceuticals or Fast Moving | | | | intervene and took over UTI's payment |
| Consumer Goods) which is why they are more | | | | obligations on itself. Currently, no AMC in India |
| risky than equity funds that invest in multiple | | | | offers assured return schemes to investors, |
| sectors.b) Foreign Securities Funds: Foreign | | | | though possible. |
| Securities Equity Funds have the option to invest | | | | 4) Fixed Term Plan Series: Fixed Term Plan Series |
| in one or more foreign companies. Foreign | | | | usually are closed-end schemes having short-term |
| securities funds achieve international diversification | | | | maturity period (of less than one year) that offer |
| and hence they are less risky than sector funds. | | | | a series of plans and issue units to investors at |
| However, foreign securities funds are exposed to | | | | regular intervals. Unlike closed-end funds, fixed |
| foreign exchange rate risk and country risk.c) | | | | term plans are not listed on the exchanges. Fixed |
| Mid-Cap or Small-Cap Funds: Funds that invest in | | | | term plan series usually invest in debt / income |
| companies having lower market capitalization than | | | | schemes and target short-term investors. The |
| large capitalization companies are called Mid-Cap or | | | | objective of fixed term plan schemes is to gratify |
| Small-Cap Funds. Market capitalization of Mid-Cap | | | | investors by generating some expected returns in |
| companies is less than that of big, blue chip | | | | a short period. |
| companies (less than Rs. 2500 crores but more | | | | ANALYSIS OF DEBT AND EQUITY FUND |
| than Rs. 500 crores) and Small-Cap companies | | | | Debt Funds |
| have market capitalization of less than Rs. 500 | | | | - They must be repaid or refinanced. |
| crores. Market Capitalization of a company can be | | | | - Requires regular interest payments. Company |
| calculated by multiplying the market price of the | | | | must generate cash flow to pay. |
| company's share by the total number of its | | | | - Collateral assets must usually be available. |
| outstanding shares in the market. The shares of | | | | - Debt providers are conservative. They cannot |
| Mid-Cap or Small-Cap Companies are not as liquid | | | | share any upside or profits. Therefore, they want |
| as of Large-Cap Companies which gives rise to | | | | to eliminate all possible loss or downside risks. |
| volatility in share prices of these companies and | | | | - Interest payments are tax deductible. |
| consequently, investment gets risky. | | | | - Debt has little or no impact on control of the |
| | | | company. |
| 1. Diversified Equity Funds - Except for a small | | | | - Debt allows leverage of company profits. |
| portion of investment in liquid money market, | | | | Equity Funds |
| diversified equity funds invest mainly in equities | | | | - They can usually be kept permanently. |
| without any concentration on a particular | | | | - No payment requirements. May receive |
| sector(s). These funds are well diversified and | | | | dividends, but only out of retained earnings. |
| reduce sector-specific or company-specific risk. | | | | - No collateral required. |
| However, like all other funds diversified equity | | | | - Equity providers are aggressive. They can |
| funds too are exposed to equity market risk. One | | | | accept downside risks because they fully share |
| prominent type of diversified equity fund in India | | | | the upside as well. |
| is Equity Linked Savings Schemes (ELSS). As per | | | | - Dividend payments are not tax deductible. |
| the mandate, a minimum of 90% of investments | | | | - Equity requires shared control of the company |
| by ELSS should be in equities at all times. ELSS | | | | and may impose restrictions. |
| investors are eligible to claim deduction from | | | | - Shareholders share the company profits. |
| taxable income (up to Rs 1 lakh) at the time of | | | | Importance of using Debt Funds: |
| filing the income tax return. ELSS usually has a | | | | - Debt is not an ownership interest in the business. |
| lock-in period and in case of any redemption by | | | | Creditors generally do not have voting power. |
| the investor before the expiry of the lock-in | | | | - The payment of interest on debt is considered |
| period makes him liable to pay income tax on | | | | a cost of doing business and is fully tax deductible. |
| such income(s) for which he may have received | | | | Importance of using EquityFunds: |
| any tax exemption(s) in the past. | | | | - Unlike obligation of debt, your business will not |
| 2. Equity Index Funds - Equity Index Funds have | | | | have any contractual obligation to pay for equity |
| the objective to match the performance of a | | | | dividend |
| specific stock market index. The portfolio of | | | | - Equity financing also allows your business to |
| these funds comprises of the same companies | | | | obtain funds without incurring debt, or without |
| that form the index and is constituted in the | | | | having to repay a specific amount of money at a |
| same proportion as the index. Equity index funds | | | | particular time. |
| that follow broad indices (like S&P CNX Nifty, | | | | Equity financing also allows your business to obtain |
| Sensex) are less risky than equity index funds | | | | funds without incurring debt, or without having to |
| that follow narrow sectoral indices (like | | | | repay a specific amount of money at a particular |
| BSEBANKEX or CNX Bank Index etc). Narrow | | | | time. Recent deals by equity funds are much |
| indices are less diversified and therefore, are | | | | larger than in the past. And debt funds are now |
| more risky. | | | | doing larger "club" deals. Both types of funds have |
| 3. Value Funds - Value Funds invest in those | | | | more money under management than ever |
| companies that have sound fundamentals and | | | | before. More cash is chasing deals, causing overlap |
| whose share prices are currently under-valued. | | | | where both types of funds vie over the same |
| The portfolio of these funds comprises of shares | | | | company. |
| that are trading at a low Price to Earning Ratio | | | | Although these funds do not represent long-term |
| (Market Price per Share / Earning per Share) and | | | | threats to each other, secured lenders must |
| a low Market to Book Value (Fundamental Value) | | | | recognize that equity and debt funds have |
| Ratio. Value Funds may select companies from | | | | marked different characteristics, goals and |
| diversified sectors and are exposed to lower risk | | | | behaviors. The most fundamental difference in |
| level as compared to growth funds or speciality | | | | equity funds seeks to buy all of the equity of |
| funds. Value stocks are generally from cyclical | | | | companies debt funds are not constrained to |
| industries (such as cement, steel, sugar etc.), | | | | controlling equity investments. Highlighted below |
| which make them volatile in the short-term. | | | | are other major differences between the both |
| Therefore, it is advisable to invest in Value funds | | | | types of funds. |
| with a long-term time horizon as risk in the long | | | | Whether investing in debt or equity, debt funds |
| term, to a large extent, is reduced. | | | | typically demand a much more rapid exit strategy |
| 4. Equity Income and Debt Yield Funds: The | | | | than equity funds. Debt funds generally seek a |
| objective of Equity Income or Dividend Yield | | | | quick flip of their investments. However, some |
| Equity Funds is to generate high recurring income | | | | debt fund investments are "loan to own" that is, |
| and steady capital appreciation for investors by | | | | they buy debt at a deep discount with an eye |
| investing in those companies which issue high | | | | towards converting that debt to equity, then |
| dividends (such as Power or Utility companies | | | | magnetizing that equity (through a recapitalization, |
| whose share prices fluctuate comparatively lesser | | | | refinancing, sale, merger or other disposition) in a |
| than other companies' share prices). Equity | | | | short time period. This is a function of, among |
| Income or Dividend Yield Equity Funds are | | | | other things, the liquidity and leverage differences |
| generally exposed to the lowest risk level as | | | | between the two types of funds. The time-hold |
| compared to other equity funds. | | | | differences directly affect the exit strategy, risk |
| DEBT FUNDS | | | | tolerance and desired rate of return of the two |
| Funds that invest in medium to long-term debt | | | | types of funds. |
| instruments issued by private companies, banks, | | | | Thus, Investing money for short-term has |
| financial institutions, governments and other | | | | generally been an issue. As it is the interest rates |
| entities belonging to various sectors (like | | | | returns are quite low. On top of this, there could |
| infrastructure companies etc.) are known as Debt | | | | be taxation issues, which will further reduce the |
| / Income Funds. Debt funds are low risk profile | | | | effective returns. Equity funds may not be a |
| funds that seek to generate fixed current income | | | | prudent option for short-term. Therefore, we |
| (and not capital appreciation) to investors. In order | | | | need to consider mainly the interest-based |
| to ensure regular income to investors, debt (or | | | | investment options. In the equity funds, higher the |
| income) funds distribute large fraction of their | | | | risk you take, the higher the returns you can get. |
| surplus to investors. Although debt securities are | | | | Since there's a known cash flow associated with |
| generally less risky than equities, they are subject | | | | debt, the risk is less. But the returns are also less. |
| to credit risk (risk of default) by the issuer at the | | | | When compared with equity funds, the risk for |
| time of interest or principal payment. To minimize | | | | the latter may be more. This is because there's a |
| the risk of default, debt funds usually invest in | | | | steady cash flow associated with debt funds. In |
| securities from issuers who are rated by credit | | | | fact, the interest which the debt fund promises to |
| rating agencies and are considered to be of | | | | pay (known as 'coupon' in financial parlance) is one |
| "Investment Grade". Debt funds that target high | | | | of the fundamental attributes of a debt fund. |
| returns are more risky. Based on different | | | | However, debt fund shares a very fundamental |
| investment objectives, there can be following | | | | relationship with interest rates. To understand this |
| types of debt funds: | | | | relationship and how that can be used in present |
| 1) Diversified Debt Funds: Debt funds that invest | | | | day context to make money, you must |
| in all securities issued by entities belonging to all | | | | understand the basics of debt. |