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HDFC Asset Management Company Limited
 Debt & Equity Funds:
Themes, Schemes & Utility
Chapters:
o Mutual Funds - Themes & Schemes
o Purpose of debt schemes
o Debt Themes
o Indicative replacement opportunities for debt funds
o Why debt funds instead of fixed deposits?
o Debt scheme classification/features/investor suitability
o Debt fund management tips
o Equity Themes - different types of themes
o Understanding Market Capitalization
o Investing in equity funds
o Equity Linked Savings Scheme (ELSS)/Tax Saving Schemes
o Risk hierarchy illustration of equity schemes
o Risk of mutual funds as denoted by Risk-O-Meter
o Notes on mutual fund themes & schemes
o A debate whether mutual funds are better or buying stocks directly is
better
o Understanding capital gains & losses

Confidential | HDFC Asset Management Company Limited

 7.1 MUTUAL FUNDS - THEMES & SCHEMES

Mutual Fund Schemes are broadly segregated as below:

PURE DEBT SCHEMES PURE EQUITY SCHEMES

HYBRID DEBT SCHEMES HYBRID EQUITY SCHEMES

7.2 PURPOSE OF DEBT SCHEMES

Debt funds are designed to protect capital, generate income and also for rebalancing the
portfolio from time to time (moving from equity to debt). The fund manager chooses
various opportunities in this space from Call Money Market to T-Bills to Certificate of
Deposits to quality Commercial Papers from the money market to long term Govt.
securities and long term corporate debt securities with maturities ranging from one day
to 20 plus years.

The schemes are actively managed to earn the interest income that gets accrued from
time to time based on the maturity of the security. The NAV (net asset value) moves in
line with such accruals and volatility.

Debt schemes can also be invested as alternate opportunities to bank fixed deposit (as
illustrated in the table below) to achieve comparatively higher returns (compared to
fixed deposits). Since returns from fixed deposit remain to be fixed until the end of the
maturity the yield does not take into account any fluctuations in the market (such as
interest rate going up or coming down), whereas in the debt mutual funds since the
schemes are actively managed in line with the opportunities the returns can be higher
than the fixed deposit. Of course, such returns are not guaranteed, nevertheless, the
fund manager endeavors to achieve superior returns.

7.3 DEBT THEMES

(PTO for the figure)

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 INDICATIVE THEMES IDEAL INVESTING PERIOD

LIQUID FUNDS 1 day to 3 months

ULTRA SHORT TERM FUNDS 3 months to 6 months

FLOATING RATE FUNDS Maximum of one year

SHORT TERM PLANS (STP) 6 months to 1 year

FLEXI DEBT About 24 months

INCOME FUNDS 3 years & above

GILT FUNDS 3 years & above

FIXED MATURITY PLANS (FMP) 3 years & above

7.4 INDICATIVE REPLACEMENT OPPORTUNITIES FOR DEBT THEMES

Theme / Scheme Risk Attribute Time Horizon of staying Replacement

invested Opportunities
Liquid Funds (Money Low 1 day to about 3 month Savings / Current
Market Funds) of surplus/idle funds Account balances
Ultra Short Term Funds Low 3 months to about 6 Savings / Current
months of surplus Account balances
Short Term Plans (STP) Low Beyond 6 months; up to Short-term FD /
1 year of surplus Savings Account
balances
Flexi Debt Low to Beyond 1 year; up to 2 Medium-term FD (1 to
Moderate years of surplus 2 year FD)
Income Funds Moderate 3 years of surplus Long term FD
Gilt Funds Moderate 3 years of surplus Long term FD
FMPs Low to About 36 months Long term FD
Moderate 4

Note: The above data is indicative which should be construed as opportunities beyond
normal traditional Savings & Current Account balances as also short & long term fixed

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deposits. While the risk in Bank FD is almost NIL the risk in debt mutual funds are LOW
but not nil. Since the returns are higher compared to bank FD a small risk has to be taken
to achieve more returns.

7.5 WHY DEBT FUNDS INSTEAD OF FIXED DEPOSITS ?

Though debt funds are not risk-free but the objective is to achieve higher returns
compared to traditional opportunities such as fixed deposit and since debt funds are
actively managed the benefits can be utilized as opportunities. (Past performances of
various debt funds can be studied for better and broader understanding)

SNIPPET: We have learnt earlier in this chapter that savings account offers annual returns
of 4% while a bank earns approx. 7% p.a. using our surplus investing in Money Market (Call
Money). Moreover, on any income we earn we are obligated to pay taxes which could
range from the least 10% to the highest 30% depending upon the tax slab that we fall
under. So, if you are under the tax bracket of 10% and on the 4% you earned from your
Savings A/c you would pay 40 paisa as your tax leading to a post-tax income of Rs.3.60
and under Growth Option of Liquid Fund you will pay 30% tax (assuming the highest tax
paying obligation) and if your annualized earning from money market funds is 8% and
after accounting taxes of 30% still your post tax gain would be Rs.5.60 (30% of 8%). So
compare your earning with the Savings account post-tax gain with the Liquid Fund post-
tax gain. You now know which is beneficial.

Assuming you had a surplus savings account balance of Rs.25000 and you did not needed
it for the next 30 days; under normal circumstances you would have received 4% p.a.
returns by the bank and if you were to pay 10% tax on the eventual income your earning
would have been:

Savings Account Post-tax gain:

Rs.25000 x 4% / 365 x 30 days = Rs.82.19 minus 10% tax = Rs.8.22 (Post-tax gain = Rs.73.97)

Liquid Fund Post-tax gain:

Rs.25000 x 7% / 365 x 30 days = Rs.143.83 minus 10% tax = Rs.14.38 (Post-tax gain =
Rs.129.45
Even if one falls under 30% tax bracket the post-tax returns would be still be better; see
the calculation below:
Rs.25000 x 7% / 365 x 30 days = Rs.143.83 minus 30% tax = Rs.43.15 (Post-tax gain =
Rs.100.68) 5

You can see the difference with the earning on the post-tax gain basis.

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Please note that usually the Liquid Fund returns are almost equivalent to the prevailing
Call Money Rates which can be read in daily newspapers and simultaneously check with
your financial advisor for opportunities in the liquid fund investing space. 7% returns is
indicative as prevailing during Jan 2017; the returns may vary from time to time.

7.6 DEBT SCHEME CLASSIFICATION/FEATURES/INVESTOR SUITABILITY

Liquid Funds

Liquid Funds are those where the corpus gets invested in money market instruments that
mature under 91 days such as treasury bills, highly rated and highly credible corporate
debt instruments and commercial papers (CPs), certificate of deposits (CDs) and CBLO
instruments which have short maturity (less than 91 days). Usually longer maturity
papers here are avoided (those maturing from 3 to 12 months)

All liquid funds are open-ended by nature wherein money can be invested anytime with
liquidity to redeem/withdraw within 24 hours (on working days only). There are no
questions asked on the tenure of investment and can be invested even for a day and
withdraw the next day, a huge selling point and also the main reason for big investors to
flock this opportunity to park their funds temporarily. The biggest advantage of investing
in Liquid Funds are that of the historic NAV, which means if the money is invested in a
liquid fund before 2.00 p.m. on any given day (time-stamped before this time), the
investor will be given the benefit of previous day’s NAV which option is not offered in any
other debt scheme.

Risk & Return Quotient: The securities here carry very low risk of both interest rate &
liquidity risk since the scheme is mostly exposed to very short term papers; very low
default risk due to highly credible instruments issued by creditworthy
institutions/companies. No mark-to-market risk. The returns are low in line with the risk,
but comparable to short-term deposit rates of banks.

Investor Suitability: Retail / Medium Net-worth Investors (MNIs) / High Net-worth

Individuals (HNIs) / Small & Medium Enterprises (SMEs) / Large Investors (individuals and
corporate entities) can be the target investors to invest in this type of scheme. Those
who maintain idle balances in their Savings or Current A/cs can choose to invest here.
Also for those investors who need liquidity on short notice to meet a pre-planned
commitment which a bank FD may not provide the convenience ideally investshere.
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Moreover, investing in a bank term deposit is cumbersome because tenure of staying
invested has to be specified as to how long the money will be invested and if it is
withdrawn prematurely a penalty is levied. The returns earned in Liquid Funds are

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comparable to returns from savings account and short-term bank FD returns and also is
tax efficient under dividend option (especially for individuals in the highest taxation
bracket). With very low risk, efficient tax rates, easy entry & exit options Liquid Funds are
ideal for very short-term parking ranging from one day to about three months. The initial
investment amount is Rs.5000 as lump sum.

Examples: HDFC LIQUID FUND / HDFC CASH MANAGEMENT FUND

SNIPPET: On our Savings Account balances a bank pays us an annual interest rate of 4%;
did we ever think what the bank does with “our” excess or surplus money and on what
basis they still pay us some nominal interest? Simple, the banks invests “our” money in
short term debt instruments (predominantly money market instruments) which earns
them returns in the range of 7% to 9% p.a. which is double than what they pay us! So, our
lack of financial literacy or lack of awareness of investment instruments we let the banks
earn out of our idle money while we get paid less!
Solution - We too can invest in short term instruments such as Money Market
instruments and earn similar returns that a bank earns with our money. Choosing to park
our surplus or idle funds thru Liquid Funds is the simplest way of utilizing our short term
surpluses. You should also be aware that high net-worth individuals and institutions
usually use Liquid Funds to park their surpluses and earn handsome gains. The most
common investors who invest in liquid funds are large institutions and corporates which
includes IT companies, manufacturing companies, banks and medium enterprises who
park their temporary excesses and earn superior returns compared to returns that are
offered by traditional opportunities. Many such corporates park their surpluses for as
short as three days!

Ultra Short Term Funds

These are an improvised version of liquid fund, the difference being with the maturity of
papers which are marginally higher compared to liquid funds, ranging from three months
and up to one year (mostly about six months maturity). Ultra Short Term Funds,have
very limited mark-to-market, except for the mark-to-market aspect which is almost nil in a
liquid fund, the portfolio is almost similar to that of a liquid fund with exposure to CD,
CPs and other corporate debt instruments. This too is an open-ended scheme with no
entry load or exit loads.

Risk & Return Quotient: Low risk investment. Thesefunds are exposed to a very limited
interest rate risk in such circumstances where the fund has taken those instruments 7
which have mark-to-market in a portfolio. Usually the fund manager avoids having
unrated papers in this scheme to avoid any risk to the portfolio. Returns are slightly
higher than the Liquid Funds.
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Investor Suitability: Due to its efficient tax rates retail/MNIs/HNIs/SMEs/corporate bodies
who expects slightly higher return invest their idle/surplus money into this scheme.
Similar to liquid funds, purchase/redemption is done within one day (T+1). There is no
historical NAV but the investment day NAV like any other scheme is offered. A very
sought after debt scheme and can be invested in all seasons and situations who wants to
safely park their surplus/idle funds for a short term duration. Ideal duration of investing
would range from three months to about six months.

Examples: HDFC CASH MANAGEMENT FUND (Treasury Advantage Plan)

Short Term Plans

These are debt papers invested in Bond Market linked instruments usually having shorter
maturity papers ranging from less than 91 days and up to 1 year to about 3 years. It is an
open-ended scheme which offers very good returns during volatile debt markets. The
exposure of securities to over one year maturity, however, would be less. It is ideal to
invest in a falling interest rate scenario for short term investment horizon. The
investment is done in Corporate Debt and PSU Debt Papers as also a small exposure to
Money market instruments. Not much exposure is taken to G-Sec papers since they tend
to be highly volatile in such situations.

Risk & Return quotient: This is moderately riskier than Liquid/Ultra Short Term Funds due
to its exposure to bond market (papers maturing above year) and also has higher
average maturity which leads to sensitivity to interest rate fluctuations but the returns
could be very attractive during short term fluctuations in the debt market.

Investor Suitability: From time to time RBI changes the key rates like lending rates, CRR,
repo, reverse repo etc., which is a big event for the economy and the debt markets,
which has an impact on the liquidity and growth. During such events – pre-
announcement and post-announcement, debt market remains volatile and to take
advantage of such volatility investors such as retail/MNIs/HNIs/Institutions/corporate
bodies with a short to medium term holding capacity (about six to nine months) could
invest, get higher returns and exit from the investment. Generally, for STPs there will be
a minimum holding period ranging from 6 to 12 months, redeeming before this period
could attract an exit load if redeemed within one year from the date of investment.

Examples: HDFC SHORT TERM PLAN / HDFC SHORT TERM OPPORTUNITIES FUND
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Floating Rate Funds

Floating rate funds invest largely in floating rate instruments and fixed rate corporate
bonds. They are better ‘designed’ to counter volatility and mitigate risk arising from
interest rate fluctuations. This has actually translated into growth for debt fund investors
in times of volatility. In a floating rate instrument, the coupon rate (interest rate) is not
fixed; rather it is benchmarked against a market-driven rate like the Mumbai Interbank
Offered Rate (MIBOR), for instance. The coupon rate on a floating rate instrument is
adjusted to the benchmark rate – let’s say the MIBOR. So every time the MIBOR
fluctuates, the coupon rate on the instrument is adjusted accordingly, at a predefined
frequency (daily, weekly, fortnightly, monthly etc.). That is why the coupon rate is
referred to as ‘floating rate’. Notice how in this setup, the yield changes with the
fluctuation in the MIBOR (which is adjusted twice a year) and not the market price of the
instrument. As the market price plays a diminishing role in a floating rate instrument,
there is lower volatility on a day-to-day basis, which is a regular feature with a fixed rate
instrument.

These funds can be further classified as short term floating rate funds and long term
floating rate funds (based on the reset frequency). So people who are looking forward
for a short term investment with a holding period up to 3 months would invest in short
term floating rate fund and an investor willing to invest in a long term fund would invest
in long term floating rate fund. These funds are especially good in an economic condition
when interest rates are rising.

Risk & Return Quotient: The risk here is low just like liquid and liquid plus funds but
returns could be higher than liquid or liquid plus schemes in favorable market conditions.

Investor Suitability: The need to introduce floating rate funds were to take advantage of
maturity of various instruments which is done due to event related volatility in the debt
market, hence investors such as SMEs/HNIs/corporate bodies/institutions who would
want to benefit from such events in the short term and also in the long term would
choose to stay invested in short-term and/or long term plans.

Examples: HDFC FLOATING RATE INCOME FUND (Short Term Plan & Long Term Plan with
low to high average maturities)

Medium Term Plans/Flexi Bond/Dynamic Bond Funds

9
With an average maturity of about 24 months which may be as high as 60 months
depending upon the decisions made by the fund manager based on the opportunities
available these types of schemes strive to generate higher returns taking advantage of

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opportunities in the debt market over medium term. The maturity of papers would be
maintained with a mixed range of two to about 5 years. The exposure would be in govt.
securities (T-bills & dated securities), CDs, highly credible CPs & corporate debt papers.

Risk & Return quotient: Moderate risk since it could be exposed to interest rate
volatilities & credit risk. The returns would be comparable to Short Term Plans and fixed
deposits exceeding 12 months.

Investor Suitability: For those investors who can stay invested for about 18 to 24 months
and want to enhance their overall yield on investment this type of scheme would be
ideal. Investors such as retail/MNIs/HNIs/corporate bodies who typically park their funds
in banks for a period of around 24 months could invest in this opportunity. Ideal for those
investors who invest in bank FDs for a period of about 2 to 3 years fixed deposits.

Examples: HDFC CORPORATE DEBT OPPORTUNITIES FUND / HDFC BANKING & PSU DEBT
FUND / HDFC MEDIUM TERM OPPORTUNITIES FUND

Long Term Funds - Income Funds

Unlike other debt schemes like liquid, ultra short-term funds, floating rate, short term
plans & flexi-debt which have shorter to medium tenured maturity debt papers, Income
Funds are those which have longer maturity instruments. The average maturity of papers
is higher ranging from one year to over 15 years. The instruments here will be a mix of
Corporate Debt (CD) and Commercial Paper (CP), PSU Bonds and G-Secs which are
usually rated by rating agencies and also would have exposure to money market
instruments. The average maturity of the instruments would usually be over 5 years
which is to capture the opportunities in the long-term.

Income funds are much sought during softer interest rate regime, but risky during higher
interest rate regime. The chances are high of a negative return if the interest rate
scenario is not favorable.

Risk & Return Quotient: Income funds are vulnerable to both interest rate risk as well as
credit rate risk due its higher exposure to unsecured instruments. During favorable
market conditions these funds offer extremely good returns.

Investor Suitability: Since the papers held here are of longer maturity, investors with a
long term holding capacity prefer investing. Income funds are vulnerable to interest 10
fluctuations; hence during a RBI rate cut where it softens interest rates from a higher
rate, returns from income funds could be hugely profitable; ideal for retail, MNI and HNI

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investors who can stay invested for longer period and want to earn comparably higher
returns than offered by bank deposits.

Examples: HDFC INCOME FUND / HDFC HIGH INTEREST FUND

Long Term Funds - Gilt Funds

Gilt funds, as they are called, are mutual fund schemes with exclusive investment in
government securities. Government securities mean and include Central Government
dated securities (maturities ranging from 2 to 30 years), State Government securities and
Treasury Bills. The gilt funds provide investors the safety of investments made in
government securities and better returns than direct investments in these securities
through investing in a variety of government securities yielding varying rate of returns.

Risk & Return Quotient: Gilt funds, however, do have interest rate risk though it does not
have any credit rate risk due its high credibility (sovereign guarantee). Like income funds
these too will do well in a softer interest rate scenario.

Investor Suitability: Those investors for whom safety of their money is of paramount
importance would opt for investing in a gilt fund. Since the risk is only related to interest
rate investors who could hold the investment till maturity prefer investing here.
Provident Funds who can hold their investment for longer period prefer investing in gilt
funds because they would be in no hurry to withdraw funds in urgency. They can
withstand short-term fluctuations which causes temporary drop in the returns. Also ideal
for retail, semi-HNI and HNI customers who are risk averse and have a holding capacity of
over 2 to 3 years.

Example: HDFC GILT FUND (Short Term & Long Term Plan)

Long Term Funds – Monthly Income Plan (MIP) / Hybrid Debt

Seeking higher returns is a continuous quest for people. They want their money to be
safe yet want to get higher returns. It is a well-known fact that without adding even a
small element of risk, attaining a meager 1% extra returns is impossible. These Hybrid
Debt schemes were structured to give a fillip to the returns expectation of a conservative
investor by a small margin comparable to pure debt/fixed income investments. These
types of schemes would typically have a higher exposure to debt instruments and will
have a small exposure to equity stocks. Ideally the ratios are 75% & 25% equity, while a 11
few times the ratio could change up to a maximum 85% & 15%. The small exposure to
equity would help the portfolio to generate higher returns, even though it could be
higher a few percentages. Historically there have been instances while MIPs have

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consistently generated double digit returns and are exclusively designed to offer payouts
by way of dividends to investors.

Risk & Return Quotient: Most of the risk is similar to that of a pure debt scheme; but the
risk might be higher to the extent of equity exposure due to the higher risk levels
attached to equity market. It has to be noted that if both debt and equity markets are
not conducive there could chances of negative returns and also regular dividends may
not be paid. The returns are usually comparable to fixed income instruments.

Investor Suitability: Retail/MNI & HNI investors typically who are predominantly debt
investors but seek to generate slightly higher returns would invest in this scheme. That
extra dash of equity built into the portfolio makes sense to shed that ultra-conservative
approach by expecting a double digit return on investment. The regular dividend
receiving opportunity suits those investors who seek periodic income on their
investment and also which is tax efficient. Recommended to stay invested for over one
year.

Examples: HDFC MIP SHORT TERM PLAN & LONG TERM PLAN

Fixed Maturity Plan (FMP)

Another innovative product/scheme from the mutual fund houses that have garnered
huge attention from long term investors in debt who seek higher return compared to
long term fixed deposits and also wants to enjoy better post-tax returns.

FMPs are very similar to three year fixed deposits (FDs) with similar characteristics but
have better taxation benefit. FMPs are closed-ended pure debt mutual funds ideally
suited for investors who are under 20% / 30% tax bracket. Even for an investor who is the
10% tax bracket too can invest, but the workings have to be done before making such
investing suggestions. Here the mutual fund company does not allow premature
withdrawal.

The idea of FMPs have perhaps come from the fact that people invest in FDs that offer
fixed rate of interest for the entire tenure and even if the rates increase during the FD in
force the benefit of the same is not given to the investor/depositor. Moreover, with few
thousands or few lakhs the power of negotiation with a bank to get higher rate of
interest would be ruled out. To address this issue mutual funds invented FMPs that work
just like a FD but with the difference being they mobilize funds from thousands of similar
12
objective investors and invest that mobilized funds in bulk with banks issued CDs or
Certificate of Deposits (a short term money market instrument, maturity up to one year),
highly rated CPs or Commercial Papers (a short term unsecured money market

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instrument, maturity up to one year) and other similar government and corporate
securities seeking higher rate of interest which gets passed on to the investor. The
maturity of the FMP would be in line with the maturity of such instruments.

Risk in FMPs: FMPs are not bank guaranteed debt instrument instead it comes with
credit risk (possible default by the borrower, for example of a commercial paper issuer).
However, the risk is low since in short term such risks are manageable. Since the risk is
slightly higher compared to traditional FDs the returns too would be higher compared to
FDs. Fund managers seek to choose credible issuers to invest in such portfolios and
endeavor to generate better returns.

Indexation Benefit: The Income Tax department made long term capital gains on debt
mutual funds taxable up to 3 years as per the tax slab of the individual or corporate and if
held beyond three years and redeemed can seek the benefit of Indexation (20% taxes
after accounting for Indexation). This calculation offers better post-tax returns to
investors.

DEBT MUTUAL FUND TAXATION SNAPSHOT (as application up to 2016-17 financial year):

For Individual Investors:

Under Growth Option:

Short Term Capital Gains are treated as units held under Growth Option for a period of
less than 3 years from the date of investment. The income would be added to the total
income of the investor and taxed as per the tax bracket where the income falls.

Long Term Capital Gains are treated as units held under Growth Option for a period of
more than 3 years from the date of investment. Any capital gains made after this period
would be taxed at 20% after accounting for indexation.

Under Dividend Option:

Dividends are taxed under Dividend Distribution Tax (DDT) at 28.33% inclusive of levies
that are paid by the AMC. The returns at the hands of the investor would be less this
deduction.

For Corporate Investors:

Short Term Capital Gains are treated as units held under Growth Option for a period of
less than 3 years from the date of investment. Any capital gains made would be taxed at 13
30%

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Long Term Capital Gains are treated as units held under Growth Option for a period of
more than 3 years from the date of investment. Any capital gains made after this period
would be taxed at 20% after applying indexation calculation.

Under Dividend Option:

Dividends are taxed under Dividend Distribution Tax (DDT) at 30% plus applicable
surcharges30% plus applicable levies that are paid by the AMC. The returns at the hands
of the investor would be less this deduction.

7.7 DEBT FUND MANAGEMENT TIPS

From the above classification of debt schemes we have noticed that the risk from each of
the category of scheme varies from being very low risk to low risk to moderate risk
where fluctuations are linked to interest rate risk, liquidity risk & inflation risk. The
annualized return ranges from 7% to 10% (as per the prevailing yield/returns in during
2017) across the debt schemes ranging from Liquid Funds to Income & Gilt Funds. The art
of managing debt investments is to have a mix of all these schemes in a portfolio which
should be based on the customer’s risk and staying period (objective). If a customer is
parking his idle money for which there could be an immediate commitment (a week or a
month to six months) then the funds should be managed within liquid, ultra short-term
and floating rate fund schemes; whereas for those customers who do not mind taking a
higher risk and would want to stay invested for medium term to longer term (more than
six months to about three years) they should be given a mix of short-term plans, income
and gilt funds thereby enhancing the overall returns.

The basic tenet or purpose of choosing debt mutual fund scheme against traditional
option such as bank deposit is to generate higher returns. Since bank deposits offer only
a fixed return without any scope for higher return debt funds manage to offer
comparatively higher returns due to its nature of being managed actively by a fund
manager.

Even 1% to 2% more returns compared to traditional opportunities would make a lot of

sense. One should consult a good financial advisor and choose the right scheme and
option because investing in mutual fund would need some guidance for first time
investors.

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 7.8 EQUITY THEMES – DIFFERENT TYPES OF THEMES

INDEX FUND BALANCED FUND (HYBRID)

DIVERSIFIED FUNDS THEMATIC FUNDS

SECTOR FUNDS FUND OF FUNDS

GLOBAL THEME FUNDS ARBITRAGE FUNDS

Further Classification of Diversified Funds

LARGE CAP FUNDS MULTI CAP FUNDS

MID CAP FUNDS MID & SMALL CAP FUNDS

SMALL & MID CAP FUNDS

Investing in Equity Funds

Investing in equity oriented opportunities is to overcome the threats from inflation and
achieve superior returns to meet future events (ideally long term) by seizing immense
wealth creation opportunities that this market offers (based on empirical evidences). To
meet specific requirements of different types of investors (based on the aforementioned
indicative risk profiles) different types of schemes were designed.

Each of the themes/schemes can be positioned to investors based on the profiling done
(preferably by a qualified financial planner/advisor).

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 EQUITY MUTUAL FUND THEMES INDICATIVE INVESTOR INVESTMENT REMARKS
INCLUDING HYBRID THEMES SUITABILITY SUITABILITY (AS
PART OF A
PORTFOLIO)
INDEX FUNDS (exposed to only Conservative Core Portfolio (discretionary)
Sensex / Nifty stocks)
BALANCED FUNDS (Equity Hybrid - Conservative / Core Portfolio must have
about 65% Equity &about 35% Debt) Moderate
LARGE CAP ORIENTED (higher Moderate Core Portfolio must have
exposure to large cap stocks)
MULTI CAP ORIENTED (exposure to Aggressive Core Portfolio must have
all market caps)
MID CAP ORIENTED (higher Aggressive Core Portfolio must have
exposure to mid-cap stocks)
MID & SMALL CAP ORIENTED Aggressive / Ultra Tactical (discretionary)
(higher exposure to mid & small Aggressive
cap stocks)
SMALL & MID CAP ORIENTED Aggressive / Ultra Tactical (discretionary)
(higher exposure to small & mid Aggressive
cap stocks)
THEMATIC SCHEMES (Infra, Aggressive / Ultra Tactical (discretionary)
Services, Power, Consumption etc.) Aggressive
SECTOR FUNDS (Auto, IT, FMCG, Aggressive / Ultra Tactical (discretionary)
Pharma, Banking etc.) Aggressive
FUND OF FUNDS (multiple mutual Moderate / Aggressive Tactical (discretionary)
fund schemes)
GLOBAL THEMES (exposure to Aggressive / Ultra Tactical (discretionary)
international equity markets) Aggressive

7.9 UNDERSTANDING MARKET CAPITALIZATION

Before we get into learning more about equity schemes it is important to understand the
dynamics of market capitalization that depicts how big or small a company is. The same
can be identified as a measure called as Market Capitalization.

Market Caps are of two types - Full Market Cap & Free Float Market Cap.

FREE FLOAT
FULL MARKET CAPITALIZATION MARKETCAPITALIZATION

During a public offer (IPO) conducted through the Primary Market companies issue 16
equity shares by way of fresh issue of shares, offer for sale, follow-on public offers (FPO),
rights issue, qualified institutional placements (QIP), private placement, bonus and such
other fully paid equity shares. All these are equity shares of the company which consists

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of equity holdings/stakes of promoters, group promoters, strategic investors, institutions
and also general public. Once the public issue happens the equity shares held by the
promoters till the IPO will also get merged with the overall equity of the company and
the price at which the shares are issued and subscribed would constitute the MARKET
CAPITILIZATION of the company. The market cap is further classified into:

Full Market Cap: The total number of shares which constitutes the overall equity of the
company - shares issued during the IPO, any additional shares issued subsequently by
way of FPO, Rights, QIP etc. and held by all types of shareholders including promoters,
other stakeholders and general public multiplied by the current market price give us the
Full Market Capitalization of a stock/scrip.

Free Float Market Cap: Leaving those shares which are held by Promoters/Group
Promoters with controlling stake; shares held by any other persons or entities with an
intent of controlling interest; shares held by government as promoter; holdings thru FDI
route; strategic stakes by any private corporate bodies or individuals; equity held by
associate/group companies; equity held by employee welfare trusts; locked-in shares and
shares which would not be sold in the open market in normal course are treated as free-
float or outstanding shares which are in the hands of public (which are immediately
available for trading on a day-to-day basis).

The market capitalization changes daily in line with the price movement of stocks and
also if there are any changes in the shares issued to public.

To sum up – a healthy market capitalization is which captures the total tradable

(outstanding or free float) shares excluding promoters’ holding, locked-in shares, strategic
holders holding multiplied by current market price of a stock.

The stocks listed on the stock exchanges are classified based on the sector or the
industry that it belongs to. For example, Reliance Industries Ltd. is a stock categorized
under Oil & Gas sector; Infosys is under Information Technology, Ranbaxy under
Pharmaceuticals, SAIL under Steel, ACC under Cement, Maruti Suzuki under Automobiles
and so on. After these sector/industry classifications the next is to classify stocks based
on their individual market capitalization.

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Stocks are broadly classified as Mega/Giant Cap, Large-Cap, Mid-Cap, Small-Cap and Micro-
Cap. The widely used market-cap interpretation is given below:

Mega Cap or Giant Cap: Rs.50000 crore& above

Large – Cap: Rs.25000 crore to Rs.50000 crore
Mid – Cap: Rs.15000 crore to Rs.25000 crore
Small – Cap: Rs.5000 crore to Rs.15000 crore
Micro – Cap: Rs.5000 crore and below
(The above classification is indicative & generally followed by many market participants,
however the interpretation could be different from person to person/portfolio manager
to portfolio manager)

SHAREHOLDING PATTERN BASED ON PROMOTERS HOLDING & PUBLIC HOLDING (POWER GRID
CORPORATION LTD. SHARE HOLDING PATTERN AS ON 30.09.2013 as per their Follow-On Public
Offer Application Form dated December 2013):

SHAREHOLDERS DETAILS No. of Shares Percentage held

Promoter’s Holding:
Central govt. holding 3214024212 69.42%

Public Holding:
Mutual Funds 54961565 1.19%
Banks & Financial Institutions 88766192 1.92%
Insurance Companies 171916856 3.71%
Foreign Institutional Investors (FII) 793979776 17.15%
Corporates 108499912 2.24%
Individuals 188960120 4.08%
Trusts 2908871 0.06%
NRIs 3109181 0.07%
Clearing Members 2598633 0.06%
Others (qualified foreign investors) 35 0.01%
__________ ______
4629725353 100%
========== ======

The above shareholding pattern offers an understanding of the difference between shares
held by promoters which is not treated as equity available for normal trading in the market
on a day-to-day basis (Promoters’ Holding) while other shareholders’ shares (Public Holding)
would be considered as Free-float, Tradable or Outstanding shares treated as FREE FLOAT 18
SHARES termed as FREE FLOAT MARKET CAPITALIZATION.

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 MARKET CAP NAME OF INDUSTRY FULL MARKET FREE FLOAT
DESCRIPTION COMPANIES CAP (IN RS.) MARKET CAP
(IN RS.)
Mega or Giant Cap Infosys IT 232358.00 212152.00
Cos.
Maruti Automobile 180097.00 79292.00
Reliance Inds. Diversified 417613.00 208806.00

Large Cap Cos. LIC Housing Fin Finl. Services 28672.00 17203.00
Dabur India Ltd. FMCG 48380.00 15481.00
Cipla Pharma 47431.00 28458.00

Mid Cap Cos. Biocon Pharma 21420.00 7711.00

Exide Inds. Auto Ancillary 18011.00 9736.00
MRF Ltd. Auto Ancillary 22017.00 15192.00

Small Cap Cos. Amara Raja Batt. Auto Ancillary 14081.00 6759.00
Jet Airways Aviation 5024.00 1256.00
Bank of India Banking - PSU 13130.00 3939.00

Micro Cap Cos. Indo Count Inds. Textiles 3359.00 1377.00

Gabriel India Auto Ancillary 1637.00 655.00
Granules India Pharma 2857.00 1457.00
Note: The companies have been randomly selected as an illustration of how the market
caps are classified based on the Full Market Cap & Free Float Market Cap. The difference
between the Full Market Cap and the Free Float Market Cap would be held by the
promoters & group promoters.

7.10 INVESTING IN EQUITY FUNDS

INDEX FUND

The entry level investments in mutual funds for those types of investors who would like
to test the low intensity of risk in the equity space Index Funds are ideal opportunity.
Index Funds are also known as Passive Funds, the money is invested in only those stocks
which are part of the broad-based indices (Sensex or Nifty) and the fund manager even
sticks to the same weightage that the indices has given on each scrip in the index. The
NAV moves along with the indices and gives an opportunity for an investor to buy into all
the important and heavy-weight stocks of the market thru this fund. There are also 19
Index-plus schemes which add a small percentage of non-index stocks to offer more
returns than the index’s performance itself.

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Risk Quotient: It is a normal equity scheme whose risk is linked to the market (index)
performance; unlike the risk associated with other types of equity mutual funds, Index
Funds are less riskier (this statement should not be construed as it is not risky; it is only
being compared with the intensity); the risk aspect could become as high as any
diversified equity fund under inefficient market situations (when the overall market
falls).Will perform in sync with the performance of the underlying index.

Type of investors: Index stocks are usually considered to be a safe bet by investors due
to the composition of stocks. The stocks in an index are blue-chip with highest market
capitalization and offer an emotional band of safety. Those who are conservative and
seek safe investment with only large-cap exposure and want to take a calculated risk
choose index funds. Index Funds are must as part of the core portfolio for conservative,
moderately conservative & moderately aggressive investors.

Examples: HDFC INDEX FUND – NIFTY PLAN / HDFC INDEX FUND – SENSEX PLAN / HDFC
INDEX FUND – SENSEX PLUS PLAN

BALANCED FUND / EQUITY HYBRID

Balanced Funds are designed to meet the risk & return expectations of such investors
who would like to get the best of equity and debt with a higher tilt towards equity. these
are not exactly balanced with 50:50 exposure to equity and debt but are funds which has
exposure to equity and debt in the ratio of 65% and 35% respectively; some schemes
might even have an increased equity exposure up to 75% (that would depend upon the
scheme objective; the same would be mentioned in the Scheme Information Document).
Minimum 65% exposure to equity securities is a mandatory requirement due to
regulatory issues since these enjoy the equity taxation.During under-performance of
equity markets usually debt market would be doing well (a common phenomenon) which
would be a good opportunity for investors to get the best across two asset classes at
different market conditions through their investment journey.

Risk Quotient: High (due to higher equity exposure the risk will be high)

Taxation aspects: The best part of this type of scheme is the tax rates which are treated
on par with regular equity schemes (short-term gains taxed at 15% plus applicable levies
and long term gains exempt from paying taxes). As per the rule of income tax any
scheme which has 65% and more of exposure to equity is classified for equity based
taxation and hence the funds changed their composition from 50% to 65% to give the 20
benefit of taxation to investors.

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Investor Suitability: This suits moderate investors who seeks less volatility on his
investments and also seeks best of both markets.

Examples: HDFC BALANCED FUND, HDFC PRUDENCE FUND, HDFC CHILDREN GIFT FUND

DIVERSIFIED EQUITY SCHEMES

The most dynamic part of equity mutual funds are the diversified segment which throws
open a slew of investment opportunities for different types of investors who can choose
their specific types of schemes. The same is discussed hereunder:

 Large Cap oriented (higher exposure to large cap stocks)

 Multi Cap oriented (invested across market caps)
 Mid Cap Oriented (higher exposure to mid-cap stocks)
 Mid & Small Cap Oriented (balanced exposure to mid & small cap stocks)
 Small & Mid Cap Oriented (balanced exposure to small & mid cap stocks)

The above examples given are part of diversified mutual schemes where the monies are
invested across sectors, stocks and market-caps. While some schemes are dedicated
large-cap, some has a mix of large-cap as well as mid-cap and a few does invest across all
market-cap of stocks. All diversified funds are benchmarked against various indices.
While a few schemes benchmark their performance against the broad-based index such
as Sensex/Nifty, other schemes are benchmarked to other indices like BSE 100, BSE 200,
BSE 500, Mid-cap Index, Small Cap Index, CNX 100, CNX 500 etc.,

Risk Quotient: High to very high

Investor Suitability: With so many opportunities in the equity market space picking
specific sectors and stocks would be a tough task for investors. To address investing
confusions and encourage investors across different requirements diversified equity
schemes were designed that offers excellent opportunity. For those investors who seek
variety of sectors, stocks and market caps choosing different diversified themes by
mixing & matching in this space offers plenty of diversification opportunities.

Examples: HDFC CAPITAL BUILDER FUND, HDFC CORE & SATELLITE FUND, HDFC EQUITY
FUND, HDFC GROWTH FUND, HDFC RETIREMENT SAVINGS FUND – EQUITY PLAN (Multi-
cap oriented) / HDFC LARGE CAP FUND, HDFC TOP 200 FUND (Large Cap oriented) /
HDFC MID-CAP OPPORTUNITIES FUND (Mid Cap oriented) / HDFC SMALL CAP FUND 21
(Small & Mid-cap oriented)

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THEMATIC FUNDS

 Infrastructure
 Banking & Financial Services
 Commodities
 Power & Energy
 Services

Constructing portfolios based on themes are a recent invention. It is something similar to

sector funds but is slightly diversified within the spectrum (like a mezzanine theme). For
instance, if a fund chooses a theme of Infrastructure it invests in those stocks and sectors
which overall affects the entire infrastructure growth story? For example, infrastructure
as a broad theme involves steel, cement, aviation, power, real estate, construction
ancillary, shipping etc. from which sectors stocks will be picked and a thematic portfolio
is designed and managed) In this infra theme we may not find FMCG, Pharma stocks (the
same can be found in normal diversified themes. It gives an extra edge to an investment
because of its diversification though it may not fall in the total diversification category.
Besides Infrastructure theme Power, Energy and Banking &Financial Services offers
thematic opportunities. Even dedicated commodity based and agricultural growth based
schemes have also become part of thematic structures.

Risk Quotient: Very high

Investor Suitability: These types of schemes offer an aggressivetouch to the portfolio of

holdings to an investor. After investing in fully diversified schemes it makes sense to
invest in thematic type of schemes which can be termed as mezzanine and also offers
additional diversification to a portfolio. But investors have to remember that thematic
schemes should be only part of their Tactical Portfolio and NOT part of their Core
Portfolio which means only about 10% of their portfolio is recommended. And further it
has to be noted that investing in thematic is only Optional. Thematic schemes are
suitable for aggressive & ultra-aggressive type of investors.

Example: HDFCINFRASTRUCTURE FUND

SECTOR FUNDS

 Auto Sector
 Banking Sector
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 FMCG Sector
 Pharma Sector
 IT Sector

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  Power Sector
 Services Sector
 Media & Entertainment

These are dedicated or focused funds wherein the money or corpus is invested only in a
specific sector to take advantage of the opportunities that emanates from these
important sectors of our economy viz. IT, Banking, Power, FMCG, Pharma, Services and
Auto among others. The fund invests only in those stocks which are of a particular
chosen sector. One may not find a Pharma stock in an IT sector fund and vice versa is also
true.

Risk Quotient: Since these types of funds are not diversified and are focused schemes
any negative volatility in the chosen sectors could be disastrous hence the risk
component is very high.

Investor Suitability: Suitable for aggressive & ultra-aggressive type of investors who
want to take advantage of movement in specific sectors and also who understands the
risk level completely chooses sector based schemes. Sector funds are recommended as
part of an overall portfolio instead of standalone exposure, which means it should not be
part of the Core Portfolio but only as a Tactical exposure. Only about 10% exposure to the
overall portfolio would be ideal.

7.11 EQUITY LINKED SAVINGS SCHEME (ELSS)/TAX SAVING SCHEMES

Staying invested for longer time is always recommended when investments are done in
equity oriented investments. To encourage long-term investment in such assets
Government has made a provision under Section 80C of the Income Tax Act wherein an
amount to a maximum of Rs.1.50 lakh during a financial year can be invested in specific
tax saving mutual fund schemes termed as ELSS schemes which offer tax payers tax
exemptions. The amounts invested in such schemes would be compulsorily locked-in for
a period of 3 years from the date of investment and would be eligible for tax rebate.
Mutual fund houses manage dedicated ELSS schemes to facilitate such investments.
Here too the investor can opt for growth and dividend option, wherein under the growth
option the entire money, including the growth portion, if any, is not allowed to be
withdrawn until the maturity of 3 years, but under a dividend option, any dividends
declared under the pay-out option during this tenure is allowed to be withdrawn which is
treated as a tax-free income at the hands of the investor. 23

Examples: HDFC TAX SAVER FUND / HDFC LONG TERM ADVANTAGE FUND

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 7.12 RISK HIERARCHY ILLUSTRATION OF EQUITY THEMES

GLOBAL THEME FUNDS

RISK
HIERARCHY SECTOR FUNDS

THEMATIC FUNDS

FUND OF FUNDS

SMALL CAP FUNDS (COMBINATIONS)

MID CAP FUNDS (COMBINATIONS)

MULTICAP FUNDS

LARGE CAP FUNDS

BALANCED FUNDS

INDEX FUNDS
(Debt funds are at the bottom of the risk hierarchy)

THEMES &INDICATIVELY HOW RISKY THEY ARE (LOW RISK TO HIGH RISK)

7.13 RISK OF MUTUAL FUNDS AS DENOTED BY RISK-O-METER

To make a common investor understand the basic risk involved in investing in different
types of mutual funds across debt and equity themes SEBI made it mandatory for fund
houses to use a measurement of how risky is a particular scheme. In this endeavour the
fund houses have introduced “risk-o-meter” that denotes the riskiness by way of
denoting the riskiness of all types of themes & schemes:

(PTO FOR TABLE) 24

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LOW RISK – USUALLY DEBT SCHEMES WITH LOW AVERAGE MATURITY
MODERATELY LOW RISK – USUALLY DEBT SCHEMES WITH HIGHER AVERAGE MATURITY
MODERATE RISK – USUALLY INDEX BASED & HYBRID SCHEMES AND LONG MATURING DEBT
FUNDS
MODERATELY HIGH RISK – USUALLY DIVERSIFIED EQUITY SCHEMES
HIGH RISK – MID CAP, SMALL CAP, THEMATIC, SECTOR TYPES OF SCHEMES

7.14 NOTES OF MUTUAL FNDS THEMES AND STYLES

 Investors can be broadly classified as Ultra Conservative, Conservative, Moderate,

Aggressive and Ultra Aggressive.
 When a fund house launches a scheme, the primary objective is to cater to all
these types of customers. Since it is impossible to knock on the doors of
customers to check their risk appetite, AMCs launch schemes with different
themes and manage them in different styles (like managing conservatively,
moderately and aggressively)
 A customer/investor can select or choose a theme/scheme/style which suits his
exact requirement and this is exactly what a fund does.
 Fund managers work on themes like Multi Cap (picking sectors &stocks across
different market caps), Large Cap oriented (picking stocks mostly from the large-
cap space), Large & Mid-cap oriented (picking from the gamut of large & mid-cap
classified stocks), Mid-cap oriented (only stocks that are classified as mid-caps),
Mid & Small-cap oriented (having only stocks from mid & small-cap category),
Thematic (picking a theme like infra, power, services etc.), Sectoral (picking
stocks from a single sector like pharma, banking, IT etc.)
 They even have schemes which are managed with minimum churning of stocks
which can be termed as Regular Schemes and there are Opportunistic Schemes
where the stocks in the scheme are frequently churned. This is basically to cater
to different types of investors. (Churning means frequent buying and selling of
stocks in a portfolio)
 Themes are also help in designing an asset allocation based investing for investors
which is the best method of investing in mutual funds.

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 7.15 A DEBATE – WHETHER MUTUAL FUNDS ARE BETTER OR BUYING
STOCKS DIRECTLY IS BETTER

A common question asked by many investors is whether as an investment option mutual

funds are better or investing into stocks directly is better.

 Let’s understand that there can be no mutual funds without stocks since a mutual
fund is an offshoot of equity/capital markets, it is a derived product.
 The whole idea of setting up mutual funds was to mitigate the risk of selecting a
stock which has to be selected based on various technical and fundamental
researches.
 Researching a company before buying is not every investor’s cup of tea since they
will have no proper tools or facilities to assess whether an instrument/
stock/sector/price/timing is good or bad.
 Selection of a wrong instrument/company/stock could prove disastrous which
might erode the complete capital which has happened in many cases where
investors have purchased stocks only on rumours and without any research and
have ended up losing money.
 A mutual fund house will have a qualified fund manager, a full-fledged research
team, research tools and expertise to select proper instruments, sectors and
stocks and even buy and sell instruments/stocks at almost right prices and right
time which a common man/investor may not be equipped to do so.
 Another biggest advantage is even a small amount of Rs.5000 can let an investor
buy into many good stocks thru lump sum investing in a mutual fund scheme
which would have not been possible had he opted for buying directly. An amount
of Rs.500 would let him access equity markets thru systematic investment plans
which is the lowest entry route.
 Of course, we have to assume that the margin of error between your selection
and that of a fund manager’s selection is low. If he also goofs-up then there is
nothing that can be done; either hold on to a bad investment or redeem and get
out.
 A professionally managed mutual fund house has always performed better than
the overall market itself which is proven on many occasions.
 But a well-researched stocks portfolio with proper allocation of sectors and
stocks could prove to be a good investment as well.

Whether it is investing in stocks directly or investing in mutual fund schemes, we have to

understand that monitoring them regularly is important. A fund manager is as good as
26
the market itself and he too is as human as we are and at times he too can make wrong
judgments which could lead to losses. Investors too have to be judicious to get rid of
badly performing schemes.

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7.16 UNDERSTANDING CAPITAL GAINS & LOSSES

Similar to that of equity stocks, equity mutual funds too have been classified under same
tax slabs and calculations. Let’s see a few tax treatments under equity mutual fund
schemes (these remain similar to that of stocks):

 All those profits booked & losses incurred within 365 days from the actual
date of investment are treated as Short Term Gains and/or losses.
 All those profits & losses booked after a period of 365 days are termed as
Long Term Gains and/or losses.
 IT rule for equities states that all short losses can be set-off against short term
gains and the gains are taxed at the rate of 15% plus applicable levies.
 All long term capital gains are free of any taxes if earned from equity.
 Short-term capital losses can be set-off against long-term capital gains
 The dividends earned out of equity investments are fully tax-free.
 The gains or losses are calculated from the date of investment to the date of
redemption/withdrawal, it is point-to-point. But the same is filed for returns
during an assessment year.

The progressive question one should ask about investing in mutual funds is not IS IT RISKY
TO INVEST BUT TO ASK HOW TO MANAGE RISK. BECAUSE INVESTING IN EQUITY IS NOT A
CHOICE ANYMORE!!

LET’S NOT BE RISK AVERSE, BUT LET’S BE RISK AWARE

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this handbook may be reproduced or distributed in public.
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