Understanding Equity Funds: Types, Advantages & More

In one line, equity-oriented mutual funds are called equity funds. If this definition feels heavy on your understanding, you are a beginner in the field.

Don’t worry! This article will simplify the term “Equity Funds” for beginners like you.

What Are Equity Funds?

Equity financing and debt financing are two popular methods that companies use to raise capital to finance their operations, investments or growth.

Raising funds in exchange for the ownership of equity (shares or stocks) in the company to investors is called equity financing. Investors become owners of the company & they have to share the risks and rewards of the company’s performance.

On the other hand, raising funds by borrowing money from lenders with a promise of paying fixed interest is called debt financing. Investors do not get any ownership of the company.

Mutual funds that primarily focus on investing money in equity securities are called equity funds. They pool money from investors and invest it in a diversified basket of equity securities.

[Related Read: Difference Between Equity Funds & Debt Funds]

Types Of Equity Funds

Equity mutual funds can be categorized into various categories based on investment strategies.

1. Large-Cap Equity Funds

Large-cap mutual funds invest in large-cap, well-established companies with a proven track record. These companies are considered stable but they may have lower potential for growth.

2. Mid-Cap Equity Funds

Mid-cap mutual funds invest in mid-cap companies. These companies are considered more stable than small-cap companies but have less growth potential compared to small-cap companies.

3. Small-Cap Equity Funds

Small-cap mutual funds invest in small-cap companies that are in their initial phases and have higher potential for growth but these companies also bring a high level of risks.

4. Multi-Cap Equity Funds

According to SEBI guidelines, a multi-cap fund must hold at least 75% of the assets in equities & equity-related instruments. Moreover, it must invest 25% of its assets in small-cap, 25% in mid-cap and 25% in large-cap companies. Read more.

5. Flexi-Cap Equity Funds

Unlike multi-cap funds, flexi-cap funds do not have any predetermined specific mandates or allocations. This means the fund manager has the freedom to allocate funds across market segments based on market conditions, valuation opportunities and growth prospects. Read more.

6. Growth Funds

Growth mutual funds primarily invest in the stocks of companies with higher growth potential. These funds focus on capital appreciation (the increase in the value of investment) and have the potential for higher returns in the long term.

7. Equity Linked Saving Schemes (ELSS)

With a lock-in period of three years, ELSS mutual funds invest in equity and equity-related securities of companies and are designed to avail certain tax exemptions.

8. Sectoral/ Thematic Funds

Mutual funds that invest in a specific sector such as tech, pharma etc. are called sectoral funds. On the other hand, mutual funds that may invest in different sectors focusing on a specific theme are called thematic funds.

9. Index Funds

Mutual funds that aim to track the performance of a specific market index such as Nifty50 are called index funds. Index funds invest in all or a representative sample of the securities in the underlying index. Read more about index funds.

10. Contra Funds

With a contrarian approach to investing, contra funds invest in undervalued stocks that are underperforming due to some temporary issues. These stocks may perform well once these issues are addressed. Know more about contra funds.

11. Dividend Yield Funds

Dividend yield funds are a type of mutual fund that primarily invests in equities of dividend-paying companies. Fund managers usually select companies that declare high dividend yields. Know more.

Please note that this is not an exhaustive list & there are many other categories of equity mutual funds available to investors.

Advantages Of Equity Funds

Let’s explore the advantages of equity funds.

1. Equity mutual funds are managed by professionals
2. These funds have a higher potential for growth in the long-term
3. Equity funds offer diversification which spread risk across multiple investments
4. Equity funds offer liquidity giving the flexibility to buy or sell their fund units on any business day
5. Some equity mutual funds (such as ELSS) offer tax benefits

Disadvantages Of Equity Funds

Here are some disadvantages of equity funds.

1. Equity funds may show higher volatility in the short-term
2. There is always a risk of losing a portion or all of the invested capital if the underlying stocks in the fund’s portfolio decline significantly in value.
3. Despite professional management, not all equity funds perform well compared to their benchmarks
4. Some equity funds may be heavily invested in specific sectors which can lead to concentration risks

Taxation Of Equity Funds

Equity mutual funds are subject to dividend distribution and capital gain taxes as follows.

A. Short-Term Capital Gains (STCGs): If you sell your investments before the holding period of one year, a tax of 15% will be deducted on gains on investments.

B. Long-Term Capital Gains (LTCGs): If you sell your investments after the holding period of one year, an LTCG of up to 1 lakh is tax-free. Over this amount, a tax of 10% will be deducted from gains on investments.

C. Dividend Income Taxes: Dividend income is now subject to tax in the hands of investors as regular income and taxed according to applicable income tax slab rates.

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