How are Mutual Funds Classified? How Do They Behave in the Market?
With over 40 Asset Management Companies (AMCs) and thousands of mutual fund schemes in India, choosing the right fund can feel overwhelming. To bring clarity and uniformity, SEBI introduced a standardized classification system that organizes all mutual funds into 36 distinct categories across 5 broad groups.
Understanding this classification not only helps you pick the right fund but also sets realistic expectations about how your investment might perform across different market conditions.
SEBI's Mutual Fund Classification Framework
In October 2017, SEBI mandated a standardized categorization of mutual fund schemes. This framework ensures that funds with similar investment objectives are grouped together, making comparison easier for investors. Each AMC can offer only one scheme per category (with a few exceptions), eliminating confusion caused by multiple similar-sounding schemes.
The 5 broad categories are:
- Equity Schemes - 11 categories
- Debt Schemes - 16 categories
- Hybrid Schemes - 7 categories
- Solution-Oriented Schemes - 2 categories
- Other Schemes - 2 categories
1. Equity Mutual Funds - Classified by Market Capitalization
Equity funds invest at least 65% of their assets in stocks and equity-related instruments. They're further classified based on the market capitalization of companies they invest in.
By Market Cap
| Category | Investment Mandate | Risk Level |
|---|---|---|
| Large Cap Fund | Min 80% in top 100 companies by market cap | Moderate |
| Mid Cap Fund | Min 65% in 101st-250th companies | Moderately High |
| Small Cap Fund | Min 65% in 251st company onwards | High |
| Large & Mid Cap Fund | Min 35% each in large cap and mid cap | Moderately High |
| Multi Cap Fund | Min 25% each in large, mid, and small cap | High |
| Flexi Cap Fund | Min 65% in equity, no cap restrictions | High |
By Investment Strategy
- Focused Fund - Maximum 30 stocks across market caps (min 65% in equity)
- Value Fund - Follows value investment strategy
- Contra Fund - Follows contrarian investment strategy
- Dividend Yield Fund - Invests in high dividend-yielding stocks
- Sectoral/Thematic Fund - Min 80% in a specific sector or theme
- ELSS (Tax Saver) - Min 80% in equity with 3-year lock-in, offers tax benefits under Section 80C
Note: AMCs can offer either a Value Fund or a Contra Fund, not both.
2. Debt Mutual Funds - Classified by Duration & Credit Quality
Debt funds invest in fixed-income securities like government bonds, corporate bonds, and money market instruments. They're classified based on the maturity period of underlying securities.
By Duration/Maturity
| Category | Macaulay Duration | Ideal For |
|---|---|---|
| Overnight Fund | 1 day | Parking surplus cash |
| Liquid Fund | Up to 91 days | Emergency fund, short-term goals |
| Ultra Short Duration | 3-6 months | 1-3 month horizon |
| Low Duration | 6-12 months | 3-6 month horizon |
| Money Market Fund | Up to 1 year | Short-term parking |
| Short Duration | 1-3 years | 1-3 year goals |
| Medium Duration | 3-4 years | 3-4 year goals |
| Medium to Long Duration | 4-7 years | 4-5 year goals |
| Long Duration | 7+ years | Long-term debt allocation |
| Dynamic Bond | Variable | Flexible duration based on interest rate outlook |
By Credit Quality & Type
- Corporate Bond Fund - Min 80% in AA+ and above rated corporate bonds
- Credit Risk Fund - Min 65% in AA and below rated bonds (higher risk, higher yield)
- Banking & PSU Fund - Min 80% in bank and PSU debt instruments
- Gilt Fund - Min 80% in government securities (sovereign guarantee)
- Gilt Fund with 10-Year Constant Duration - Invests in G-secs with 10-year maturity
- Floater Fund - Min 65% in floating rate instruments
3. Hybrid Mutual Funds - The Best of Both Worlds
Hybrid funds combine equity and debt in varying proportions, offering diversification within a single scheme.
| Category | Equity Allocation | Debt Allocation |
|---|---|---|
| Conservative Hybrid | 10-25% | 75-90% |
| Balanced Hybrid | 40-60% | 40-60% |
| Aggressive Hybrid | 65-80% | 20-35% |
| Balanced Advantage (BAF) | Dynamic (0-100%) | Dynamic |
| Multi Asset Allocation | Min 10% each in at least 3 asset classes | |
| Arbitrage Fund | Min 65% in arbitrage strategies | |
| Equity Savings | Min 65% equity, min 10% debt, uses arbitrage | |
Note: AMCs can offer either a Balanced Hybrid or Aggressive Hybrid Fund, not both.
4. Solution-Oriented & Other Schemes
Solution-Oriented Funds (5-year lock-in)
- Retirement Fund - Designed for retirement planning with long-term wealth creation
- Children's Fund - For funding children's education or marriage
Other Schemes
- Index Funds - Passively track a market index (Nifty 50, Sensex, etc.)
- Fund of Funds (FoF) - Invest in other mutual fund schemes
- ETFs - Exchange-traded funds that trade like stocks
How Different Mutual Funds Behave in Bull Markets
A bull market is characterized by rising stock prices, investor optimism, and economic growth. Here's how different fund categories typically perform:
High Performers in Bull Markets
- Small Cap Funds - Often deliver the highest returns as smaller companies grow rapidly during economic expansion. Can deliver 30-50%+ returns in strong bull runs.
- Mid Cap Funds - Benefit significantly from growth momentum, often outperforming large caps.
- Sectoral/Thematic Funds - Cyclical sectors like banking, infrastructure, and real estate tend to outperform during bull phases.
- Multi Cap & Flexi Cap Funds - Benefit from exposure across market caps, with fund managers increasing small/mid cap allocation.
Moderate Performers
- Large Cap Funds - Provide steady returns but may lag behind smaller caps. Their stability means they capture a good portion of upside without extreme volatility.
- Aggressive Hybrid Funds - Participate in equity rally while debt portion provides some stability.
Lower Performers (Relative)
- Debt Funds - May underperform as investors shift to equities, though falling interest rates can boost gilt funds.
- Arbitrage Funds - Returns remain range-bound regardless of market direction.
- Conservative Hybrid Funds - Limited equity exposure restricts upside participation.
How Different Mutual Funds Behave in Bear Markets
A bear market sees declining prices, pessimism, and economic uncertainty. Here's the typical behavior:
Most Affected Categories
- Small Cap Funds - Face the steepest declines, often falling 40-60% in severe bear markets. Liquidity issues can amplify losses.
- Mid Cap Funds - Significant drawdowns, though less severe than small caps.
- Sectoral Funds - Cyclical sectors get hit hardest; can fall more than the broader market.
- Credit Risk Funds - May face defaults and liquidity issues during economic stress.
Relatively Resilient Categories
- Large Cap Funds - Established companies with strong balance sheets tend to weather downturns better. Falls are typically less severe than mid/small caps.
- Balanced Advantage Funds (BAF) - Automatically reduce equity exposure as valuations rise, providing downside protection.
- Dividend Yield Funds - Companies paying consistent dividends tend to be more stable.
Safe Haven Categories
- Liquid & Overnight Funds - Minimal impact from equity market movements; preserve capital.
- Gilt Funds - Often rally during bear markets as investors flee to safety and RBI may cut rates.
- Arbitrage Funds - Market-neutral strategy provides stability regardless of direction.
- Banking & PSU Debt Funds - High credit quality provides safety during turbulent times.
Key Research Insights on Market Behavior
Academic studies on Indian mutual funds have revealed interesting patterns:
- Performance doesn't persist across cycles - Funds that excel in bull markets often underperform in bear markets, and vice versa.
- Defensive sectors matter - FMCG, pharma, and IT sectors tend to hold value better during bearish phases.
- Stay invested for the long term - Despite short-term volatility, equity funds have historically delivered positive returns over 7+ year periods.
Choosing the Right Fund for Your Risk Profile
| Risk Appetite | Suitable Categories | Investment Horizon |
|---|---|---|
| Conservative | Liquid, Overnight, Short Duration, Conservative Hybrid | 0-3 years |
| Moderate | Large Cap, Balanced Advantage, Aggressive Hybrid | 3-5 years |
| Aggressive | Mid Cap, Small Cap, Flexi Cap, Sectoral | 7+ years |
Use Your Mutual Funds Without Disrupting Your Strategy
At DhanLAP, we understand that market timing is difficult. Selling your mutual funds during a bear market locks in losses, while selling during a bull market means missing future gains. That's why we offer Loan Against Mutual Funds (LAMF) as a smarter alternative to redemption.
With LAMF, you can:
- Access liquidity without selling - Meet financial needs without disrupting your investment strategy
- Stay invested through market cycles - Your funds continue to participate in market recovery
- Avoid timing mistakes - No need to decide when to exit or re-enter the market
- Maintain asset allocation - Keep your carefully planned portfolio intact
Whether the market is bullish or bearish, your mutual funds can work for you as collateral while continuing to grow.
Final Thoughts
Understanding mutual fund classification helps you build a portfolio aligned with your goals and risk tolerance. Different categories behave differently across market cycles - small caps offer high growth potential but with significant volatility, while large caps and debt funds provide stability during turbulent times.
The key is to diversify across categories, maintain your asset allocation, and stay invested for the long term. Remember, it's not about predicting markets - it's about being prepared for all market conditions.
