Do Mutual Funds Invest only in Equities? Not Necessarily

Dec 19, 2018 | 2 months ago | Read Time: 3 minutes | By iKnowledge Team

Apart from shares, mutual funds also invest in government bonds, company debt such as fixed deposits and certificate of deposits, debentures, corporate bonds, money market instruments such as call money and treasury bills.

Newbie investors in the markets are usually told that it would be better if they cut their teeth on investing in mutual funds instead of directly in the stock markets. The idea is that mutual funds carry a lower risk than direct investments in market-linked instruments such as stocks. A perception is thus created in the minds of investors that mutual funds invest only in shares.

This perception has been bolstered by numerous business channels, investment magazines and personal finance columns, all of which talk about how mutual funds are performing and link it to the performance of the stock markets. Since the focus is on equities and equity mutual funds, investors and lay people can be forgiven for thinking that mutual funds are all about equities.

So where else do mutual funds invest? Here we give you a list of non-equity schemes that will give you some investment ideas.

Debt

Historically there has been more money flowing into debt schemes or income funds rather than equity oriented schemes also called as growth funds. However, with stock markets showing spectacular returns in the last four years, a lot of money has been flowing into equity schemes.

Debt or income funds as they are called, invest in a range of fixed income instruments, that is instruments or securities that have a fixed rate of return on them. This includes:

  • Fixed deposits that can be issued by both banks and companies. They have a specified time period ranging from a few months to five years and carry a fixed rate of interest.
  • Corporate bonds and debentures that are debt securities issued by different types of companies. Both corporate bonds and debentures usually have a face value, and carry a rate of interest. They can also be traded on exchanges and mutual fund units get their value from the changes in the traded prices.
  • Government securities are debt issued by the government to raise funds for its various programs. They are secure since they carry a sovereign guarantee.

One of the advantages of debt or income funds is that since they invest in fixed income securities, there is some certainty of returns. They are called income funds for this reason. Due to this feature, they are also less risky compared to equity schemes. The risk in debt schemes arises from changes in interest rates – when the interest rates fall, the price of the debt security (if they are listed and are traded) rises and when interest rates rise, the price of the debt security falls, thereby affecting the net asset value of the mutual fund units. (However, please note that all market-related securities carry risk and mutual funds do not guarantee any returns)

Talking of guaranteed returns, Aegon Life’s Guaranteed Growth Insurance Plan is a savings plan that delivers what it promises. So there is both growth as well as security in the form of returns. Investors get guaranteed annual payouts of 150% of the annualised premium, which ensures regular cash flows. In the case of death of the insured, future premium payments are waived and the nominee gets the annual payouts.

Liquid or Money Market Funds

Mutual funds also invest in money market instruments and such funds are called as liquid funds or money market funds. The instruments they invest in are of very short duration, ranging from overnight up to 90 days. Due to the short nature of the investments, there is very little volatility in the price of the securities and such funds are the least risky among all the categories of mutual funds.

The instruments they invest in are:

  • Treasury bills, which are extremely short term debt issues of up to a year are issued by the government. Since they have sovereign guarantee they carry the least risk.
  • Certificates of deposits, which are short term debt certificates issued by banks and financial institutions. They also carry an interest rate.
  • Commercial papers are debt securities issued by corporates and financial institutions.
  • Overnight call money market, is an overnight loan market for banks (mostly) and lending and borrowing takes place to tide over short term funding demands.

Investors need to realise that even an equity scheme will have a small portion of debt in its portfolio, as a stabiliser and to counter the volatile nature of stocks.

So, if equity is not for you, then you know where to invest, right?

II/Dec 2018/4697

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