Equity mutual funds are a type of mutual funds that invest the majority of the pooled capital of investors in stocks and related securities. The key advantage of investing in an equity mutual fund is that investors get exposure to equity markets through a qualified fund manager who may make the relevant rebalancing activities in your portfolio so as to minimize risks and capture maximum returns from the segment. Let’s explore equity funds in detail.

This article covers:

What is an equity mutual fund?

Equity mutual funds invest in equities of companies and offer diversification of portfolio across equity market segments such as market capitalization or specific industries or themes in the hopes of earning substantial returns. 

The large exposure to equity gives equity mutual funds the potential to outperform debt and hybrid funds in terms of returns, however, the risk is also higher in equity funds.

Advantages of investing in equity mutual funds

You may invest in the stock market through equity funds without having to worry about picking individual stocks or sectors. Equity mutual funds have skilled fund managers to conduct research on your behalf. The following are some of the benefits of investing in equity funds:

  • Experts are in charge of your investment
  • Fractional buying of shares
  • Diversification of portfolio within a single investment
  • Convenient to buy and sell, which means there’s no requirement to time the market
  • Plenty of options suitable to investors’ preferences
  • Investing in a systematic manner is an option (as instalments through SIP)
  • It provides versatility and liquidity

What are the taxation rules for equity funds?

The following are the tax rules for equity funds:

Tax on capital gains

If you hold the units of equity funds for less than a year, the capital gains you earn are known as short-term capital gains or STCG. When STT tax is applied, then STCG is applicable at 15%.

Long-term capital gains, or LTCG, are realised when you retain the scheme’s units for longer than a year. The tax rate for LTCG is 10% over and above 1 lakh.

Tax on Dividend Distributions (DDT

This tax is deducted at the point of sale. As a result, when the mutual fund pays out dividends, DDT is deducted before the payment is distributed.

Types of equity mutual fund

Investment strategy-based categorization

  1. Theme and sectoral funds based on investment strategy: An equity fund may choose to follow a certain investment theme such as an international stock theme or an emerging market theme. Some schemes may also invest in a specific market sector, such as BFSI, IT, or pharmaceuticals. It’s worth noting that because they focus on a certain area or theme, sector or theme-based funds incur a higher risk.
  2. Focused equity fund: This fund invests in up to 30 equities of companies with market capitalizations that are specified at the time of the scheme’s commencement.
  3. Contra equity funds: These equity fund schemes comb the market for under-performing equities and buy them at bargain prices with the expectation that they will rebound in the long run.

Tax treatment-based categorizatio

  1. Equity Linked Savings Program (ELSS): ELSS funds are the only equity scheme that offers tax benefits under Section 80C of the Income Tax Act. These plans have a three-year lock-in period.
  2. Non-tax saving equity funds: All other equity funds, with the exception of ELSS, are non-tax saving plans. This means that the profits are taxable as capital gains.

Categorization of investment styles

  1. Active funds: These funds are actively managed by fund managers who select the stocks to comprise the fund and monitor it carefully for possible rebalancing opportunities in order to capture maximum returns. 
  2. Passive funds: These funds usually mirror a market index and consist of the same stocks in the same quantity and weightage as the composition of the fund. The fund manager is not involved in the stock selection in these schemes.

According to market capitalization

  1. Large-cap equity funds: Large-cap equity funds invest in large-cap companies that are well-established and can provide consistent returns.
  2. Mid-cap equity funds: Mid-cap firms, according to the Securities and Exchange Board of India (SEBI), are those that are classified between 101 and 250 in terms of market capitalization. Mid-cap equity funds invest in such companies.
  3. Small-cap equity funds: Small-cap funds are mutual funds that invest in small-cap companies. Small-cap funds are more vulnerable to market volatility and risk, which investors should be aware of.
  4. Multi-cap funds: Multi-cap funds invest in stocks with a range of market capitalizations. Depending on market conditions, the fund manager picks the stocks and rebalances across market capitalization.

Things to note when investing in equity mutual funds

Expense ratio

The expense ratio of actively managed equity funds is generally high because of the frequent buying and selling of shares. For equity funds, the Securities and Exchange Board of India (SEBI) has set an upper limit of 2.5%. Investors will benefit from a lower expense ratio since their returns will be higher. Now that you’re aware of what expense ratio is, you can use this understanding in shortlisting stocks on Tickertape App for Muhurat Trading. If you’re unaware of what is Muhurat Trading, it is a one-hour trading session that investors believe to be auspicious. Watch this space for more information on Muhurat Trading!

Holding period

Just like stocks, holding equity mutual funds for the longer term may yield good returns as the value of the underlying assets increases, cumulating for fund growth. Also, when investors redeem their fund units, they realise capital gains. Short-term capital gains tax is generally higher than long-term capital gains on equity mutual funds.

Fund houses pool your money and invest it in equity funds after conducting extensive research. It is, therefore, critical to comprehend the underlying workings of equity funds. This includes understanding the equity fund’s goal and matching it to your risk profile. The asset allocation of the fund follows next, followed by the investment plan. Last but not least, you should be aware of the fund’s expense ratio as it may have an impact on results.

Manonmayi

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