What Are Equity Funds in India? A Beginner’s Guide

An equity fund, sometimes known as a stock fund, is a form of mutual fund that predominantly invests in equity and equity-related securities.  These funds allow investors to engage in the stock market while distributing risk over a diverse portfolio. Equity funds can be actively managed, which means that fund managers can make choices to purchase and sell stocks of companies to beat the market, or passively managed, which means that investments are meant to mimic the performance of a certain stock market index, such as the Nifty 500, Nifty 100, Nifty 50. Equity-based mutual funds provide investors with an opportunity to participate in the stock market through a diversified portfolio.

Now we know what equity funds are, let’s look at their distinguishing features.

Low Expense Ratio

A lower expense ratio in an equity fund indicates lesser costs connected with the fund’s oversight and operation. It denotes that while an equity fund trades shares in its portfolio often, the expenses associated in the process, such as transaction charges, management fees, and administrative overhead, are kept to a minimum. This is an important consideration for investors since a reduced expense ratio equates to a more productive and economical investment. 

Securities and Exchange Board of India (SEBI), the regulatory body in charge of mutual funds in India, has established a maximum cost ratio for equity funds, which is presently fixed at 2.5%. This limit guarantees that the overall costs of operating the fund do not exceed this level. Furthermore, SEBI may consider further reductions in this highest point in the future, which might be viewed positively by investors.

A lower expense ratio is advantageous to investors since it means that a bigger proportion of the potential equity mutual funds returns are kept by the investors. With reduced expenditures, a bigger portion of the fund’s potential gains are returned to investors, potentially resulting in better net equity mutual funds returns. 

Diversification

Investing in diversified equity funds may potentially lessen the risk associated with a single company’s bad performance by investing in a diverse selection of stocks across numerous industries, sectors, and geographical locations. Potential gains from multiple investments might potentially help balance possible losses if one company or industry underperforms.

Tax Exemption

The taxation of equity-based mutual funds is complicated by restrictions that depend on the holding duration of funds units. For example, if you redeem your Equity Fund investment within a year after investing in them, any gains obtained from this move are categorized as Short-Term Capital Gains (STCG). The earnings you earned are subject to a 15% tax rate in this situation. 

If, on the other hand, you keep your Equity Fund investment for more than a year before redeeming it, you will be subject to Long-Term Capital Gains (LTCG) tax. The tax rate for long-term capital gains on equity mutual funds is 10% on gains exceeding Rs. 1 lakh in a financial year. A long-term equity fund may be a strategic alternative for investors seeking to capitalize on the potential benefits of equity investments over a lengthy investment horizon. ELSS, a type of Equity mutual fund, allows you to minimize your taxable income. According to Section 80C of the Income Tax Act of 1961, it permits you to save up to 1.5 lakhs in taxes every year. While more can be invested, sums greater than 1.5 lakhs will not generate extra tax benefits under Section 80C.

Equity funds, which are classified according to various criteria, provide a wide range of investment choices within the world of mutual funds. These specialist categories accommodate investors’ individual tastes, risk tolerance, and financial goals. Investors may build their portfolios to match their own strategies by categorizing equity funds based on specific variables such as market capitalization and investing style.

Equity Funds Classified by Market Capitalization:

Large-Cap Equity Mutual Funds: These invest in firms with market capitalizations ranging from 1 to 100. They are relatively less risky and may provide stability with potential long-term returns.

Mid Cap Equity Fund: These funds make investments in firms rated 101 to 250. They are less risky than small-cap funds but may have greater potential for growth than large cap equity funds.

Small Cap Equity Fund: Invest in firms with a market capitalization which rank greater than 250. These may have a higher risk, and higher potential equity mutual funds returns.

Large- and Mid Cap Equity Funds: These funds divide the equity allocation between mid- and large cap equity fund firms for a well-balanced combination of potentially strong returns and aims to achieve stability.

Multi-Cap Equity Mutual Funds: These funds invest in equities of all market capitalizations, with minimum 25% allocation to large, mid and small caps each. . This may be suitable for   broad market exposure.

Equity Funds Classified by Investment Styles:

Active Management: Most equity funds are actively managed, with portfolio decisions made by the fund management. 

Passive Management: Index mutual funds, on the other hand, such as those following the Nifty50 or Sensex, are passive and replicate index composition. Because of the lesser management, these have lesser TER (Total Expense Ratio).

Sectoral Funds:  These equity funds specialize in certain industries or sectors such as pharma, FMCG, technology, or infrastructure. The success of these designated industries or sectors has a strong influence on potential returns.

Equity mutual funds are further classified depending on a number of characteristics. For starters, they are frequently grouped based on the size of the enterprises in which they invest. Some funds concentrate on large cap firms, which are well-known and established corporations with substantial market capitalizations. Others focus on mid cap firms  or small-cap firms, which are often smaller and may have more room for development. The fund’s investment strategy and risk profile are reflected in the size of the firm.

Investing in equity mutual funds is a dynamic and extensively used strategy that provides investors with an entry point into the world of stocks and equities. These investment vehicles, recognized for their ability to provide potentially optimal returns, each have their own set of benefits and drawbacks. Read on to look at the primary advantages and disadvantages of investing in equities mutual funds. 

Advantages of Equity Funds: 

Equity funds in India have several advantages including:

Diversification

Diversification is a basic risk-mitigation approach used by equity mutual funds. These funds avoid overexposure to any single company or industry by diversifying their assets across many equities and sectors. This conservative strategy serves as a buffer against rapid market shocks that might affect individual stocks or sectors owing to a variety of variables. Equity fund investment is a strategic choice for those seeking to participate in the potential growth of companies within a diversified portfolio.

Flexibility

Investors may pick from a variety of equity mutual funds, including large-cap, mid cap equity fund, small-cap, and sector-specific funds, allowing them to match their investments to their risk tolerance, financial goals, and investment horizon.

SIP

Equity mutual funds provide the convenience of SIP. Equity SIP allows investors to contribute modest, regular sums at defined times. This methodical approach makes investment more affordable and helps to potentially maximize the power of compounding over time.

Tax Advantages

Investing in Equity-Linked Savings Schemes (ELSS) provides an appealing opportunity for tax savings. The only type of mutual fund eligible for tax deductions under Section 80C of the Income Tax Act of 1961 is an ELSS fund or an equity-linked savings program. By investing in ELSS mutual funds, you may get a tax rebate of up to Rs 1,50,000 and save up to Rs 46,800 in taxes every year. This implies that your ELSS investment can be deducted from your taxable income, thus lowering your tax.

Furthermore, mutual fund investments in general, including ELSS, provide tax benefits when held for a lengthy period of time.

Disadvantages of Equity Funds: 

Investing in equity funds may have certain drawbacks. They include:

Capital Gains Taxation

Equity mutual funds are subject to long and short-term capital gains. 

STCG Tax: If you redeem equity mutual fund units within one year after investing, the profits are termed short-term capital gains. These are taxed at a higher rate, which reduces your overall profits.

Tax on Long-Term Capital Gains (LTCG): While LTCG on stock mutual funds is lower than STCG, it is not completely tax-free. According to current tax legislation, LTCG on equity funds that surpass a certain threshold are taxed at a rate of 10%. This tax may have an influence on after-tax returns.

Exposure to Risk

Equity mutual funds are naturally vulnerable to market volatility. Depending on market conditions, the value of your investments might grow or decline dramatically. Because of this risk, equity funds may be inappropriate for investors with limited risk tolerance.

Longer Investment Horizon

While equity funds may deliver good long-term returns, they may not be appropriate for short-term financial goals. These funds are primarily focused on medium to long-term goals, making them less liquid for consumers who want immediate access to their money.

• The guide aims to answer what are equity funds. Equity funds, also known as stock funds, are a type of mutual fund primarily investing in stocks. They enable investors to participate in the stock market with risk spread across a diversified portfolio.
• Investing in equity mutual funds in India provides investors with a gateway to the dynamic and promising Indian stock market, offering potential for capital growth and wealth creation in the long term.
• Equity oriented mutual funds, with their focus on stocks, are favored by investors seeking higher return potential while accepting associated market risks.
• Equity funds are often categorised based on the size of the companies they invest in.Large cap equity funds focus on well-established corporations with substantial market capitalization. Mid cap equity funds target medium-sized firms, while small cap equity funds invest in smaller, growth-oriented companies.
• Equity mutual funds offer diversification, reducing risk by spreading investments across various stocks and sectors, a challenging feat for individual investors. Investors can choose from a variety of equity fund types, aligning their investments with their risk tolerance and financial goals. Equity mutual funds provide the convenience of SIP, enabling disciplined, affordable, and compounding-focused investments. Equity-linked savings schemes (ELSS) offer tax benefits under Section 80C of the Income Tax Act, 1961. 
• Equity mutual funds may incur short-term capital gains (STCG) tax if units are redeemed within a year and long-term capital gains (LTCG) tax on gains exceeding a certain threshold. These funds are subject to market volatility, making them unsuitable for risk-averse investors. 
• Equity funds are best suited for medium to long-term goals and may not be liquid enough for short-term needs.