A mutual fund is a professionally managed company that collects money from many investors and invests it in securities such as stocks, bonds and short-term debt, equity or bond funds and money market funds.
Mutual funds are a good investment for investors looking to diversify their portfolio. Instead of betting everything on one company or sector, a mutual fund invests in different stocks to try to minimize portfolio risk.
The term is typically used in the US, Canada and India, while similar structures around the world include the SICAV in Europe and the open-ended investment firm in the UK.
Do equity and debt funds have different risk factors?
Equity funds invest in
shares of companies while debt funds invest in company bonds and money market instruments. Because these funds invest our money in different assets, they are influenced by risk factors that affect the underlying asset classes.
Stocks are influenced by market movements. So market risk is the single most important risk factor affecting equity funds. International equity funds also face currency risk due to exchange rate fluctuations. Equity funds are more prone to economic and industrial risks as stocks are directly affected by factors that affect a company’s business and economic environment.
Bonds are affected by changes in interest rates as bonds are nothing more than a kind of lending instrument. Therefore, interest risk is the biggest risk factor affecting debt funds. Bonds are also subject to default and credit downgrades, i.e. the likelihood that a bond issuer will not meet payments under the bond or enter a financial crisis that could cripple its ability to honour bond payments. So debt funds face significant default and credit risk.
Both types of funds are subject to liquidity risk, i.e. the fund manager may find it difficult to sell certain holdings of the portfolio if they are poorly traded or due to lack of demand for that security.