Mutual fund, as we know, is a pool of money invested by a large number of investors across various securities such as stocks, bonds, fixed income securities, etc. Broadly, the money gets invested in equity and debt funds.
Equity fund is broadly classified into Large Cap Equity Funds, Mid Cap Equity Funds, Multi Cap Equity Funds, Thematic Equity Funds and Equity Linked Saving Scheme. These funds offer you higher return on your investment and thus increasingly becoming the choice of investors. But there are risks also involved. First talk about the benefits.
The most significant benefit of equity funds is the capital appreciation of the investors. The company usually reinvests the earned profit so that it grows with the increasing market share, rise in product developments and others. As the company attains higher growth, its stock prices start to move up and thus accentuate the growth of investor capital.
Fund managers of Asset Management Companies (AMCs) make sure your portfolio gets diversified with reasonable investment across various stocks in different sectors at different stages. This is done to offset the possible loss in value of a particular stock with the rise in the others.
You can generate dividend income regularly with equity funds that invest money in blue chip companies who normally pay regular dividends irrespective of the economic condition. Typically, the dividends are paid quarterly. With diversified portfolio, you are likely to receive a steady flow of income during the year.
Like your savings account, stocks are also liquid in nature as they get traded in all the major exchanges across the world. As an investor, you can sell your stocks whenever you wish to and get the proceeds of the same in a week’s time.
However, don’t get swayed away by the benefits as there are certain risks associated with equity funds.
Macro Economic Risks
Sensitivity of stock market in relation to the domestic and international economic developments is massive. Any change in interest rates, up and down in currency, surge in inflation, policy changes with respect to tax rates can cause a sharp fall in the price of the stock you may have invested into. With this, the profitability also takes a dig.
There are many stocks whose prices are denominated in foreign currencies. And if the equity fund invests a certain portion of the capital in such stocks, then your investment is exposed to currency risks. With the changes in value of foreign currencies in relation to the Indian rupee, the value of the equity fund may be adversely affected.
Corporate Performance Risks
It is not sure that the performance of the company will continue to remain good over a period of time. The reason could be the sudden spike in costs or cut down in the revenue volume. The company’s performance can also get worse in the face of sharp fall in demand for their products due to the rapidly changing consumer behaviour. The drop in the performance will adversely affect the mutual fund NAV as the stocks of such companies get battered in the exchanges.
The trading volume determines the liquidity of stocks. A fall in the volume of stocks may prevent fund managers to sell the securities and could well pull down the NAV of the fund. It is being observed that funds that invest in small cap or unlisted stocks face liquidity risks.
Even though mutual fund eliminates or minimises internal or company related risks via diversification, but a specific sector or segment of equity market may hold a significant proportion of the fund's assets. In that case, your money may get exposed to non-diversification risks.
Country & Political Risks
Equity funds do feel the heat if political unrest happens in the home country or the foreign soil. Due to this, there can be possibilities of reduced or no mobilisation of financial assets and unprecedented exchange controls. As a result, you could see the negative effects in the value of your mutual fund.