Before starting out, allow us explain that we have made it as simple as one can make. To the extent that if after some time you would think that this is over-simplified classification.
The main reason why some of you may find a different classification at other places is because there is lack of standardization; each mutual fund house, regulator, expert etc has their own classification. So we have presented the broad classification that you must know for successful investing.
Anyways let us go ahead and understand these classification.
1. Based on the option of entry and exit, Mutual Funds are of basically of two types, open-end and closed-end. They are fairly simple.
Open-end: In an open-ended fund, an investor can invest at any point of time. Also the investor has the option to exit the fund according to their convenience. The units of the funds is bought and sold directly from the fund.
Close-end: Contrary to open-ended funds, an investor cannot invest in fresh units of a fund after the fund is launched. Also investors are not allowed to exit the fund before the sate as stated in the objective or at the time of the launch.
To provide liquidity or lets say to allow an investor to exit from the investment, closed-end funds are listed on the stock exchange, where they can be traded like the stocks.
2. The other level of segmentation among funds are based on where they invest. If you have asked why we used 'the other level of segmentation', then its because primarily all funds are either open-end or close-end and then they are further classified further on.
2.1 Equity Funds invest maximum part of the money they are entrusted with in equities holdings i.e. in stocks. The structure of the fund may vary for different schemes in its objective and how it defines each sector. Other thing that distinguishes each fund are the fund manager"s outlook on different stocks.
These can be of further variety like
Diversified Fund: These type of funds, invest in all stocks irrespective of the category, sector, classification that they represent.
Sector Specific Fund: Also there are funds that cater to a single sector or theme like infrastructure, bank, FMCG, pharmaceutical etc.
2.2 Debts Funds have the objective to invest in various forms of debt papers. Government authorities, private companies, banks and financial institutions are some of the major issuers of debt papers. By investing in debt instruments, these funds ensure low risk and provide stable income to the investors. Now there are sub classification in these also.
Gilt Funds: They invest all their assets in securities issued by Government, popularly known as Government of India debt papers. These funds stated to carry zero 'default risk' but are associated with interest rate risk. They are considered safe as they invest in only papers backed by Government.
Income Funds: Funds with such focus tend to invest a major portion into various debt instruments such as bonds, corporate debentures and Government securities.
Short Term Plans (STPs): Meant for investment horizon for three to six months. These funds primarily invest in short term papers like Certificate of Deposits (CDs) and Commercial Papers (CPs). Some portion of the corpus is also invested in corporate debentures.
Liquid Funds: Also known as Money Market Schemes, These funds provides easy liquidity and are expected to provide preservation of capital, meaning the amount you have invested should not reduce. It is somewhat similar to a fixed deposit but not as safe. These schemes invest in short-term instruments like treasury bills, inter-bank call money market, CPs and CDs. These funds are meant for short-term cash management of corporate houses and are meant for an investment horizon of 1day to 3 months. They considered to be the safest amongst all categories of mutual funds.
2.3 Then the third type known as hybrid funds, as the name implies, their mandates are to invest in both equities and debts. The distribution between equity and debt depends on the objective statement of the mutual fund scheme.
Balanced Funds: Balanced funds are kind of hybrid fund. But the major portion of their kitty is invested in equities. This has been done due to some regulatory purposes.
Monthly Income Plans (MIPs): They invest maximum portion of their total corpus in debt instruments while they take minimum exposure in equities. It gets benefit of both equity and debt market. But do not go by its name, there is no assurance or guarantee that an investor will receive an income every month if one has invested with this fund. These funds are mostly heavy on debt.
2.4 Exchange Traded Funds (ETFs) These are called so, because they can be traded on a stock exchange. ETFs are passively managed funds where they will be following an index and their target will be to mirror the index in performance. Since they are not actively managed the annual expenses charged by these funds are less.
2.5 International Funds. Well the name says it all. These funds tend to invest internationally.