Dr Dhiraj unveils equity mutual funds’ DNA on DifferentTruths.com—your regulated bridge from FDs to market growth, blending wealth pursuit with discipline.

For many retail investors, equity mutual funds represent the first structured step into the world of market-linked growth. They sit between the extremes of direct stock investing, which requires significant time and expertise, and traditional savings instruments like fixed deposits (FDs), which prioritise safety over inflation-beating growth.

Understanding the DNA of an equity mutual fund is essential before choosing any category within it. This column explores how these funds balance the pursuit of wealth with the necessity of regulation and discipline.

1. The Core Architecture: The 65% Rule

At their heart, equity mutual funds are pools of capital invested predominantly in the shares of listed companies. However, this isn’t left to the whims of the fund house.

Under SEBI (Securities and Exchange Board of India) regulations, specifically the categorisation and rationalisation norms, a fund must invest at least 65% of its total assets in equities to be classified as an equity fund for tax and regulatory purposes. Recent 2025/26 updates have refined this, allowing funds more flexibility to use the residual portion for assets like REITs and InvITs to enhance diversification.

Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) are relatively new investment vehicles that allow individuals to invest in large, income-generating assets without owning them directly. REITs invest primarily in commercial real estate such as office buildings, malls and warehouses, while InvITs invest in infrastructure assets like roads, power transmission lines and pipelines. These structures pool money from investors and generate regular income through rent or usage charges, a significant portion of which is distributed to investors as payouts.

In India, REITs and InvITs operate under SEBI regulations, which mandate transparency, periodic disclosures and minimum payout requirements. While they offer the potential for steady income and diversification beyond traditional equities and fixed deposits, they are still market-linked instruments, and their prices can fluctuate. REITs and InvITs are therefore best understood as long-term income-oriented investments rather than guaranteed or risk-free options.

Example: If you invest ₹10,000 in an Equity Fund, SEBI ensures that at least ₹6,500 is actively participating in the stock market. The remaining 35% can be held in debt, gold, or cash. This buffer allows the fund manager to handle redemptions without being forced to sell stocks at a loss during a market dip.

2. Professional Management: Outsourcing the Headache

One of the most significant advantages of mutual funds is professional management. While an individual investor might buy a stock based on a tip or a hunch, a fund manager operates within a rigorous framework. Fund managers are responsible for researching companies and assessing their financial health by studying balance sheets, cash flows and business prospects. They also closely track broader economic conditions, including monetary policy decisions of the Reserve Bank of India. For example, when the RBI cuts repo rates, borrowing becomes cheaper for companies, which can support business growth. Such signals often influence how fund managers adjust equity exposure.

To ensure that fund managers’ interests remain aligned with those of investors, SEBI has introduced a ‘skin in the game’ rule. Under this regulation, fund managers and key personnel are required to invest a portion of their own salary into the schemes they manage. This means that if the fund performs poorly, they share the financial impact along with investors, reinforcing accountability and discipline.

3. Diversification: The Only Free Lunch

Direct stock picking often leads to concentration risk. If you own only three stocks and one fails, 33% of your wealth vanishes. Equity mutual funds mitigate this through diversification.

By spreading capital across multiple stocks and sectors, the fund ensures that the failure of one company doesn’t sink the entire portfolio. SEBI enforces a 10% cap, meaning a fund generally cannot invest more than 10% of its NAV in a single company’s shares, ensuring no single stock has too much power over your money.

For example,during the 2020 pandemic, while the hospitality and aviation sectors crashed, the IT and pharma sectors thrived. Diversified equity funds were able to smooth the ride because the gains in one area offset the losses in another.

4. SEBI’s Categorisation: Comparing Apples to Apples

Before SEBI’s landmark categorisation rules, fund names were often confusing. Now, every fund must fit into a specific box with clear investment rules:

Table 1: SEBI’s categorisation

To prevent clutter, SEBI generally allows only one scheme per category per fund house. This ensures that a fund house doesn’t launch ten different ‘growth funds’ that all do the same thing.

5. Transparency and the New 2026 Regulations

The regulatory landscape is constantly evolving to favour the investor. Starting April 1, 2026, SEBI has notified the Mutual Funds Regulations, 2026, which introduce a major shift in how you see your costs:

• Unbundling of Costs: Instead of a single Total Expense Ratio (TER), funds must now disclose a Base Expense Ratio (BER). Statutory costs like GST, Stamp Duty and STT will be charged on actuals. This makes it crystal clear how much you are paying the manager versus how much is going to the government.
• Performance-Linked Fees: SEBI is exploring a model where the management fee could be linked to the fund’s performance against its benchmark.
• The Risk-o-meter: Every fund must display a visual Risk-o-meter (ranging from Low to Very High). As of 2025, SEBI also requires Information Ratio (IR) disclosures, helping you see if the manager is actually generating Alpha return (extra return) for the risk they are taking.

6. Volatility vs. Risk: The Role of Time

A common hurdle for new investors is the daily fluctuation of the NAV (Net Asset Value). Because equity funds reflect market prices, their value changes every day.

It is vital to distinguish between volatility (temporary price swings) and risk (permanent loss of capital). While the RBI doesn’t regulate mutual funds, its management of inflation dictates the cost of money. In a high-inflation environment, equity valuations might face pressure, but a disciplined Systematic Investment Plan (SIP) uses this volatility to your advantage via Rupee Cost Averaging.

Rupee Cost Averaging is a simple investing concept that helps reduce the impact of market ups and downs. It means investing a fixed amount of money at regular intervals, regardless of whether markets are rising or falling. When markets are high, the fixed amount buys fewer units. When markets fall, the same amount buys more units. Over time, this evens out the average cost at which units are purchased. As a result, investors do not need to worry about timing the market or predicting short-term movements. This approach is commonly seen in systematic investment plans (SIPs) in mutual funds. Rupee cost averaging works best over long periods and suits disciplined investors, especially beginners and cautious savers. While it does not guarantee profits or eliminate market risk, it helps manage volatility and encourages consistent investing without emotional decision-making.

Conclusion: A Vehicle, not a Shortcut

Equity mutual funds are not get-rich-quick schemes. They are professionally managed, highly regulated and transparent vehicles designed for disciplined participation in India’s economic growth. Understanding these structural safeguards is the first step toward becoming a confident investor.

In the next column, we begin our deep dive into the bedrock of any portfolio: large-cap mutual funds.

Picture design by Anumita Roy

Dr. Dhiraj Sharma

Dr Dhiraj Sharma is a faculty member in the Department of Management Studies at Punjabi University, Patiala. He has authored fourteen books and published over a hundred research papers, articles, and book-chapters in reputed national and international journals, books, magazines, and web portals. Beyond academia, he is a nature and wildlife photographer and a realistic and semi-impressionist painter.

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