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What are Growth Mutual Funds?

  • Feb 15, 2024

However, these funds can be more explosive than other mutual funds and are better served by those who are comfortable with taking on additional risk and have longer investment horizons.

This article aims to compare the potential returns and risks associated with growth funds and to help investors determine if they are a good fit for their portfolios.

Understanding of Growth Mutual Funds

Growth mutual funds are mutual funds that specifically target stocks with strong growth potential across different sectors and companies. This equity fund aims to provide capital appreciation over the long term by investing in companies operating in high-growth domains. This contrasts with other fund types focused more on income generation or risk management objectives.

When considering growth funds, retail investors should analyse the underlying investment approach, risk-return dynamics, fees, taxation, and overall suitability relative to individual investor profiles and preferences.

Investment Philosophy and Stock Selection

The fundamental investment thesis for growth stock mutual funds lies in identifying enterprises that exhibit potential for superior earnings growth in future years. Fund managers deploy extensive research to shortlist resilient companies with distinct competitive strengths, leading to strong and sustainable growth runways ahead.

Some key aspects fund managers may evaluate include the addressable market size, sales and profit growth trajectories, financial strength, quality of management, enduring brand equity, and technological edge. Companies meeting these criteria and trading at reasonable valuations make it to final portfolios.

By investing in such relentlessly growing firms early on, funds aim to benefit from the disproportionate price appreciation and wealth creation that good growth stocks mutual funds can demonstrate in bullish conditions. However, this focused approach also subjects investors to heightened volatility.

Risk Profile of Growth Funds

Despite prospects of higher returns, investors must recognise that growth mutual funds also present higher risk parameters than category averages. Fund portfolios exhibit higher concentration across fewer stocks, sectors, or market capitalisation levels.

Further, the companies that growth funds invest in usually command higher valuation multiples, owing to their superior growth history and optimism around prospects. Any adverse events or execution missteps weighing earnings growth can translate into magnified stock price corrections due to expanded valuations.

Therefore, investors should expect intermittent periods of high volatility while anticipating healthy long-term growth. Those with moderate risk appetites may prefer diversified equity or hybrid funds instead.

Potential Returns Over the Long Run

Growth funds in India have shown the ability to deliver high returns during extended equity bull runs while lagging market returns during broader consolidations or corrections. Top quartile growth funds have managed 15-20% CAGR returns over extended 7-10 year periods through economic ups and downs.

Retail investors should, therefore, invest in growth stock mutual funds with return expectations aligned with India's long-term equity growth trajectory. Maintaining 7-10-year investment horizons aids in mitigating interim volatility risk while benefiting from the superior earnings potential of growth stocks.

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Fee Structure and Cost Considerations

As actively managed funds, growth mutual funds tend to have higher expense ratios than passive index-tracking funds. However, investors in growth funds pay for the expertise of seasoned fund managers in identifying high-potential stocks through in-depth research.

Expenses can vary from as low as 1% for larger funds to 2.5% or more for mid-sized offerings, depending on research costs, portfolio turnover, and operational overheads. Investors must account for these recurring fees while estimating overall returns. Choosing funds with competitive expenses enhances net returns.

Taxation Framework

Growth funds primarily hold investments for long-term capital gains taxed at 10% post-indexation benefit. Short-term gains for assets held under 12 months attract a 15% tax. As per investor income tax slab rates, dividend income is also subject to taxation. Considering post-tax returns is vital while selecting schemes.

Who Should Consider Growth Funds?

Growth mutual funds appeal more to informed investors who agree with the underlying investment tenet of growth stocks outperforming broader markets over extended periods. Specifically, they may suit:

1. Young investors with 15-20-year investment horizons

2. Folks looking to accumulate funds for long-term objectives

3. Those with higher risk tolerance willing to ignore interim volatility

4. Investors seeking focused exposure to India's rising sectors

However, those seeking growth and income mutual funds or portfolio stability may find better alternatives in debt, hybrid, or balanced offerings.

How do Growth Funds Compare with Other Categories?

When compared to other mutual fund varieties in India, growth funds differ in the following aspects:

1. Higher risk profile than debt funds providing capital protection

2. Singular growth focus, unlike balanced funds, presents integrated equity and debt allocation

3. Target growing firms rather than undervalued stocks like value funds

4. Remain more diversified across sectors than thematic funds

Hence, suitability ultimately depends on individual portfolio objectives and risk parameters.

Conclusion

Retail investors should analyse historical 3-year and 5-year trailing returns against category peers and benchmark indices when evaluating growth mutual funds. The Nifty 200 or S&P BSE 500 are appropriate benchmarks for diversified growth funds.

Beyond returns, fund concentration, manager tenure, and portfolio turnover also provide valuable perspectives into portfolio stability. Investors should review both quantitative and qualitative factors before investing.


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by Team Sharekhan

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