Equity mutual funds are one of the most popular and lucrative investment options for NRIs who want to participate in the Indian stock market and benefit from its growth potential. However, choosing the right equity fund can be a daunting task, given the plethora of options available in the market.

Before we jump right into how to select equity mutual funds, let’s understand what they are and the different types available.

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What are Equity Mutual Funds?

Equity mutual funds invest primarily in shares of companies listed on the stock exchange. They aim to provide capital appreciation and income to the investors over the long term. Equity mutual funds can be classified into different types based on various criteria, such as

Market Capitalisation: This refers to the company's size in terms of its total market value. Based on this, equity funds can be categorised as large-cap, mid-cap, small-cap, multi-cap or flexi-cap funds.

Large-cap funds invest in the top 100 companies by market capitalisation, mid-cap funds invest in the next 150 companies, small-cap funds invest in the remaining companies, and multi-cap and flexi-cap funds invest across market capitalisations.

Investment Style: This refers to the approach or philosophy the fund manager adopts to select stocks for the portfolio. Based on this, equity funds can be categorised as value or contra funds.

Value funds invest in stocks undervalued by the market, and contra funds follow a contrarian investment strategy.

Investment Objective: This refers to the fund's specific goal or theme to invest in stocks. Based on this, equity funds can be categorised as ELSS, thematic, sectoral, dividend yield, or focused funds.

ELSS funds are tax-saving funds that invest in equity and offer tax benefits under Section 80C of the Income Tax Act.

Thematic/ Sectoral funds invest in stocks related to a particular theme or sector, such as infrastructure, consumption, technology, banking, pharma, or FMCG. 

Dividend yield funds invest in stocks that pay high dividends to the shareholders. 

Focused funds invest in a limited number of stocks (up to 30) across sectors and market capitalisations.

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How to Select the Right Fund?

Selecting the right equity fund depends on factors such as your investment and fund-specific parameters.

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Investor-Specific Parameters

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Investment Goal

Having definitive investment goals before investing will help you pick the right fund. Each mutual fund caters to different investment goals. 

For example, if your goal is to save tax, you can opt for ELSS funds. If your goal is long-term capital appreciation, you can invest in large, mid, small, multi or large & mid-cap funds. 

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Tenure

Your investment duration will also help you pick a fund that suits your tenure. Equity funds are suitable for long-term investments, offering higher returns and lower volatility. However, the duration of your investment may vary depending on the type of fund you choose. 

For example, large-cap funds are relatively less risky and can offer stable returns for 3 to 5 years. Mid-cap and small-cap funds are riskier and more volatile but can offer higher returns for 5 to 7 years. 

Multi-cap and flexi-cap funds can offer a balance of risk and return for 4 to 6 years. ELSS funds have a lock-in period of 3 years, which means you cannot withdraw your money before that. 

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Risk Appetite

Your risk appetite will also determine the type of fund that will suit your profile. Risk appetite determines your ability and willingness to take risks in your investment. Equity funds are inherently risky and are subject to market fluctuations and uncertainties. However, the degree of risk may vary depending on the type of fund you choose. 

For example, large-cap funds are less risky than mid-cap and small-cap funds, as they invest in well-established and stable companies. You should choose a fund that matches your risk profile and does not expose you to undue stress or anxiety.

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Fund-Specific Parameters

Apart from the factors specific to you, you should also consider some fund-specific parameters that can help you evaluate the quality and performance of the fund. These parameters include:

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Fund’s Historical Performance

Evaluate the fund's past returns over varying periods, like 1, 3, 5, or 10 years. While past performance doesn't guarantee future results, it provides insights into the fund's performance across different market cycles.

Compare the historical performance to its category average and benchmark index. Look for a fund that has consistently outperformed its category and benchmark over the long term and has stayed within its expected returns.

Assess the fund's performance during different market cycles - bull and bear phases and see how the fund has managed to cope with the changing market conditions.

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Expense Ratio

The Expense ratio is the annual fee the fund house charges for managing your money. It is expressed as a percentage of the total assets of the fund. The expense ratio includes various costs, such as management fees, administrative fees, marketing fees, distribution fees, etc. 

The expense ratio reduces the net returns of the fund, as it is deducted from the Net Asset Value (NAV) of the fund. 

The expense ratio of equity funds in India can range from 0.5% to 2.5%, depending on the type and size of the fund. You can compare the expense ratios of different funds in the same category and pick the one with a lower ratio.

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Fund Manager

The fund manager’s expertise and experience also matter when picking a fund. The fund manager decides which stocks to buy, sell, or hold and how to allocate the money among different stocks. 

Choose a fund with a qualified and experienced fund manager who churns the portfolio based on market conditions and fund objectives. Invest in a fund with a manager who has a proven track record of consistent and superior returns over the long term. 

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Exit Load

Exit load is the fees charged by the fund house during redemption or switching fund units, expressed as a percentage of the NAV. It reduces the net returns for the investor. Opt for funds with minimal or no exit load. Exit loads vary based on fund type and tenure, ranging from 0% to 2%.

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Size of the Fund

The fund's size, expressed as Assets Under Management (AUM), represents the total invested amount. Opt for a fund with a moderate size, signalling popularity and scalability without compromising performance and flexibility.

Very large funds may encounter issues like liquidity, diversification challenges, and concentration risks, impacting portfolio balance. On the other hand, very small funds may face viability challenges, lacking investor support for sustained existence and growth.

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Asset Management Company (AMC)

The Asset Management Company (AMC) sponsors and manages the fund, overseeing its performance, regulatory compliance, and investor service. Choose a fund affiliated with a reputable AMC, characterised by a strong brand, extensive history, substantial asset base, high-quality research team, and reliable customer support.

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Choosing Between Passive and Active Strategies

Another way to classify equity funds is based on their investment strategy, which can be either passive or active. 

Passive investing replicates a benchmark index, like Nifty 50 or Sensex, by investing in the same stocks in proportion to the index. Passive funds, such as index and exchange-traded funds (ETFs), have a low expense ratio as they do not require active management or research. 

They also have a low tracking error (the difference between the fund's returns and the index). Passive investing is suitable for those who want to invest in the broad market and are satisfied with the average returns of the index.

Active investing is a strategy that involves selecting stocks that can outperform the benchmark index using various analysis methods, such as fundamental, technical, quantitative, etc. 

They have a higher expense ratio, requiring active management and research. Active investing is suitable for investors who want to generate higher returns than the market (index/ benchmark) and are willing to take higher risks for higher returns.

The choice between the two largely depends on your risk tolerance level and return expectations. While passive funds are known to generate returns as close to that of the underlying benchmark, active funds have the potential to generate higher returns. 

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At a Glance

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Conclusion

Investing in Indian equity mutual funds as an NRI offers growth potential, but choosing the right fund requires careful consideration of factors like investment goals, tenure, and risk appetite. After investing, you must regularly review and adjust your portfolio according to market conditions. 

The process may seem quite daunting. And not everyone will have the expertise, knowledge and time to manage their investments. You can hire an investment advisor (iNRI) to help you identify and manage the right funds. 

At iNRI, we help you stay updated with the latest market trends and news and provide personalised advice and recommendations. We also optimise your tax liability and currency risk and ensure you comply with the regulatory norms and the Foreign Exchange Management Act (FEMA) rules.

Try iNRI, where we have curated investment themes based on different goals for different investors. Pick the one that best suits your investment goals, or speak to us, and we’ll help you pick the right fund.

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