One of the major advantages of a globalized world is that investment opportunities are not limited to first world countries. There are thousands of mutual funds available to South African investors today. From funds that invest in remote countries, to funds that focus on commodities, and everything in between, chances are that if you can dream up an investment strategy, there’s probably a mutual fund already doing it.
All these choices can be overwhelming and it can be difficult to find a mutual fund that meets your needs. In this article, we’ll help narrow down the universe of mutual funds by discussing common styles of equity mutual funds.
We will examine the risks, potential returns, and how you can find a fund that might be right for you.
Common styles of equity mutual funds
Equity mutual funds invest in stocks. Because there are many types of stocks, there are many styles of equity mutual funds.
A common way to classify different types of stocks is by market capitalization, which is a company’s dollar value. Stocks are broadly grouped into three market capitalization sizes: small, medium, and large.
These are referred to as small cap, mid cap, and large cap. Small-cap stocks have market capitalizations of less than R10 billion.
Mutual funds that focus on small-cap stocks typically offer the highest risk and return potential. Mid- cap stocks have market capitalizations between R10 and R50 billion.
Mutual funds that focus on mid-cap stocks typically offer slightly lower risk and return potential than small-cap funds.
Large-cap stocks have market capitalizations of more than R50 billion. Mutual funds that focus on stocks of this size typically offer slightly lower risk and return potential than mid-cap funds.
Equity mutual funds may focus on one market capitalization or they may overlap across all three. In addition to market cap, stocks are grouped by type, namely, growth or value.
Growth stocks are usually younger companies that offer higher risk and return potential than value stocks. In contrast, value stocks are typically older companies that may be more financially stable and may pay dividends.
Mutual funds focused on growth stocks offer higher risk and return potential than mutual funds focused on value stocks.
Some mutual funds invest in a mix of growth and value stocks. These are known as blended mutual funds and they may fall between growth and value in terms of risk and return potential. Investors can get a better idea of the risk and return potential of mutual funds based on the types of stocks they hold.
Small-cap growth funds offer the highest risk and return potential. Mid-cap blend funds are in the middle in terms of risk and return. And large-cap value funds offer the lowest risk and return potential.
Risk and Return Profiles
Now that you know the common styles of equity mutual funds, and their risk and return profiles, let’s discuss how to find a fund that might fit your needs.
Finding the right fund should be based on your risk tolerance and time horizon. Investors with high risk tolerance and longer time horizons might search among small-cap growth or blend funds, and mid-cap growth funds, because they offer the highest risk and return potential.
Conversely, investors with low risk tolerance and shorter time horizons might search among large-cap value or growth funds, and mid-cap value funds.
Some investors might fall somewhere in the middle, which is when a mid-cap blend fund might be a good fit. Investors may want to avoid choosing funds that might hold similar stocks. For instance, small-cap value and small-cap blend funds probably hold some of the same stocks.
Investing in funds that hold the same stocks could increase risk. Instead, investors should consider funds that hold different stocks. For example, it’s unlikely that large-cap value and small-cap growth funds share holdings. Investing in these types of funds increases diversification and reduces risk.
Don’t let the universe of mutual funds overwhelm you. Now that you understand the common equity fund styles, along with their risk and return potential, finding the right fund for you could be easier than you think.
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