Mutual funds, ETFs, AIFs
Intuition
Most individual investors lack the time, expertise, or capital to build diversified portfolios of individual securities. Pooled investment vehicles solve this by aggregating money from many investors and deploying it professionally according to a defined mandate. The three most important categories in India are Mutual Funds, Exchange-Traded Funds (ETFs), and Alternative Investment Funds (AIFs).
Mutual funds are the most accessible, available to retail investors with as little as ₹500 per month via SIP. ETFs offer the lowest costs for passive investors who want market returns without active management. AIFs are restricted to high-net-worth investors (minimum ₹1 Cr) and include private equity, hedge funds, and venture capital.
Understanding costs, tax treatment, and liquidity differences between these vehicles is essential for making informed investment decisions, and for building financial models for asset management companies.
Mechanics
Mutual funds vs ETFs vs AIFs at a glance:
| Mutual funds | ETFs | AIFs | |
|---|---|---|---|
| Who can invest | Anyone, including retail investors | Anyone, bought on NSE or BSE like a share | High-net-worth and accredited investors only |
| Minimum | As little as ₹500 a month via SIP | One unit, at its market price | ₹1 crore |
| Buying and selling | At NAV on any business day (open-end funds) | Intraday on the exchange, at market price | Limited: AIF investments are illiquid |
| Cost | Expense ratio capped by SEBI, up to about 2.25% for smaller active equity funds; Direct plans cost less than Regular | Much lower, for example 0.05 to 0.20% for a Nifty 50 ETF | Varies by fund |
| What they hold | By SEBI category: large-cap, mid-cap, small-cap, flexi-cap, ELSS, liquid, gilt, hybrid and more | Usually an index, gold or government bonds | Category I: infrastructure, venture capital, SME and social impact; Category II: private equity, real estate and debt, no leverage; Category III: hedge funds, can use leverage |
| Tax | Equity funds: 12.5% on long-term gains above ₹1.25 lakh, 20% on short-term gains; debt funds at your slab rate | As for mutual funds of the same type | Depends on the AIF category |
| Suited to | Most investors, including SIP investors | Passive investors who want market returns at low cost | Wealthy investors who can commit ₹1 crore and accept illiquidity |
Mutual Funds (SEBI MF Regulations):
- Open-end: Buy/sell at NAV any business day. Most Indian MFs are open-end.
- Close-end: Fixed units issued at NFO; listed on exchange; trade at discount/premium to NAV
- Categories (SEBI categorisation circular): Large-cap, mid-cap, small-cap, flexi-cap, ELSS, liquid, overnight, gilt, credit risk, hybrid, each with defined investment universe and limits
- Expense Ratio (TER): Annual fee charged as % of AUM. Capped by SEBI (e.g., active equity: up to ~2.25% for smaller funds). Directly reduces investor returns.
- Exit Load: Penalty for early redemption (e.g., 1% if redeemed within 1 year for equity funds)
ETFs (Exchange-Traded Funds):
- Listed on NSE/BSE; bought/sold intraday at market price (not NAV)
- Creation/redemption mechanism by Authorised Participants (APs) keeps price close to NAV
- Much lower TER than active funds (e.g., Nifty 50 ETF: 0.05–0.20%)
- Tracking error: Difference between ETF returns and index returns, lower is better
- Key Indian ETFs: Nifty 50 ETFs, gold ETFs, Bharat Bond ETFs (G-sec based), sectoral ETFs
Alternative Investment Funds (SEBI AIF Regulations):
- Category I AIF: Infrastructure funds, VCFs, SME funds, social impact funds
- Category II AIF: Private equity, real estate funds, debt funds, no leverage
- Category III AIF: Hedge funds, long/short equity, can use leverage
- Min investment: ₹1 Cr. Open only to accredited/HNI investors
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