August 23 , 2012
There are about more than 1000 mutual funds schemes in India. As an investor what is the first thing you would look for to choose a fund from among these? Many people might be tempted to select the fund that maximizes their return without paying attention to other equally important aspects.
Each mutual fund has a definite investment objective decided by the AMC's fund management team. It remains fairly constant throughout the fund's existence. A fund's investment objective dictates its asset class and also investment style in case of equity funds which is the approach used to identify stocks.
A fund's investment objective conveys 2 things: the goal of the fund and time horizon. Sometimes it may also specify the type of instruments that will be employed to achieve these two things. All mutual funds in the world have the goal of either generation of income or appreciation of invested capital. Some funds aim to do both simultaneously. Next, the time horizon tells how much time is required to achieve the goal. It can be over the short term or a long term. In mutual fund parlance, short term refers to a period up to three years, long term is over five years and anything between these is medium term. Some funds have very short duration of a few days or months. This does not mean the fund expires after the period, instead it means that the instruments the fund invests are of very short duration so expected returns will be generated within that period.
Classification of funds by investment objective
Broadly speaking all mutual funds fall under one of the following asset classes:
- Equity funds
- Debt funds
- Liquid funds
In any sort of investment, risk and return go hand in hand. Higher the returns expected from any investment, higher will be the risk of loss of invested capital. Even the safest forms of investment have some element of risk in them.
Equity funds usually have the investment objective of capital appreciation over the long term. They invest in stocks of companies.
Debt funds invest in fixed-income securities such as bonds, debentures, certificate of deposit, commercial paper and so on. Their investment objective is income generation over short term to long term. If the term is short the instruments chosen will be of short maturity period and for long term funds instruments such as corporate bonds and government bonds.
The investment objective of liquid funds is to ensure protection along with enhancement of capital and provide high level of liquidity. These funds invest in money market instruments of very short duration not greater than 91 days.
Choosing funds by investment objective
An investor while selecting fund to invest in must pick from those funds whose investment objective matches his/her own. For instance if you want to create a corpus to sponsor your child's education 10 years down the line, you must choose from equity funds. If your goal is to achieve adequate capital appreciation to provide fund a vacation three years down the line you can choose from a balanced fund. If you are a person nearing retirement and generating a source of regular is of prime concern you should choose from debt funds. Liquid funds are mostly suitable for parking amounts of money for very short duration to earn slightly income than banks usually do.
When you have identified the investment objective you can compare funds for their performance and go for the one that has been in the game for a reasonable period of time and has a proven track record.
Where to find it
Every fund's investment objective is clearly laid down in all documents relevant to it, such as the Key Information Memorandum, Scheme Information Document and Monthly Factsheets. All these are mandatory and found on respective mutual fund's website or one can find them all at AMFI site.
So next time, before scouring returns of funds for selecting one, get down to identifying your investment objective and limit your selection to funds that match it.