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.
Which type of equity fund has the lowest risk and which has the highest?
Mutual funds are subject to a variety of risk factors depending on the categorization and therefore their underlying portfolios. Mutual funds are subject to many risks, but the most significant is market risk. Mutual funds as a category are considered “high risk” investment products. While all equity funds are exposed to market risks, the degree of risk varies from fund to fund and depends on the type of equity fund.
Large-cap funds that invest in shares of large-cap companies, i.e. shares of consolidated companies with solid finances, are considered the least risky because these shares are considered safer than shares of mid-cap and smaller companies. Low-risk mutual funds usually have a well-diversified portfolio that is distributed across sectors of the large-cap category. Index funds and ETFs based on broad-based market indices that follow a passive strategy are also considered low-risk as they mimic well-diversified market indices.
Targeted funds, sector funds and thematic funds are at the other end of the risk spectrum because they hold concentrated portfolios. High-risk equity funds usually suffer from concentration risk due to their holdings limited to one or two sectors. Although targeted funds invest in well-known large-cap stocks, they usually only hold 25-30 stocks that increase concentration risk. If the fund manager gets his calls right, he can provide a higher return than a large-cap diversified fund, but the opposite is also possible.
Sector funds invest in stocks of a single sector such as automotive, FMCG or IT and therefore carry significant risk because any unwanted event affecting the industry will have a negative impact on all stocks in the portfolio. Thematic funds invest in stocks of a few related industries that are currently in demand, but may lose long-term appeal.
Investors usually make a generalization that equity funds give a higher return than other funds, but they should be aware that all equity funds are not the same. The return potentials go hand in hand with their equity fund risk profile. So look for the degree of diversification of a fund across sectors and major holdings for any concentration risk before deciding to invest in it. Instead of looking at funds with the lowest risk or the highest return, you should look for a fund with acceptable levels of risk for you.
