Before investing in mutual funds, you need to first be aware of the different types of schemes available in the Indian securities market. One of the lesser-known types of mutual fund schemes is the capped fund. Many investors may not be familiar with this category of mutual funds. If you too are wondering what a capped fund is, this article can help you understand all you need to know about this investment option.
What is a capped fund?
A capped fund is a type of mutual fund scheme that comes with predetermined limits or restrictions on the maximum expense ratio allowed and/or the investment structure. These caps are determined by the mutual fund manager or set by the mutual fund house. They are also published in the mutual fund’s prospectus, so interested investors can be aware of such limits and make an informed decision about whether or not a capped mutual fund may be a suitable choice for their portfolio.
Example of a capped mutual fund
Let us discuss an example to better understand the meaning of a capped fund and how it works. Say a mutual fund tracks the healthcare sector and invests primarily in companies engaged in healthcare and medical manufacturing or services. However, the fund has a 20% cap on the stock composition. This means that the weightage of any individual stock in the portfolio cannot exceed 20%.
How do capped funds work?
Capped funds have predetermined limits on the expense ratio allowed. This means that the fund cannot charge fees higher than the permitted level. For investors, this translates to more affordable investments since the fees do not drastically reduce the net returns. Fund managers may adjust the limits on the expense ratio over time as needed. However, investors must be informed of such changes.
Another kind of restriction often present in capped funds is a limit on the maximum amount or weightage of individual holdings in the portfolio. No matter what kind of caps are introduced, investors will be notified of the same. This is why it is crucial to read the prospectus when you want to compare mutual funds and make a well-informed decision.
What are the advantages of a capped fund?
Capped funds offer various advantages to investors. If you are planning to invest in these mutual funds, here are some of the benefits you may experience:
- Transparent investments: You will be informed of any limits imposed on the fund’s expenses or holdings in the prospectus. This eliminates any kind of guesswork from your investment decisions.
- Better net returns: If the fund you choose has limits on the maximum expense chargeable, you can rest assured that your potential returns from the fund will not be eroded due to high investment costs.
- Minimised concentration risk: If a capped fund has limits on the maximum weightage of any individual asset, it ensures that the capital is not concentrated unfairly in any one stock or security.
Capped expenses
Capped funds need to inform investors about any limits on the expense ratio of the scheme. This cap is typically set as an upper limit, which reflects the maximum fee that a fund can charge from investors. However, the restriction is not permanent. Rather, it is often only valid for one financial year or any other specific period as mentioned in the fund’s prospectus. Thereafter, the cap may be increased or revised as needed. This could affect the net returns from the scheme accordingly.
Capped holdings
Sometimes, a capped fund may introduce restrictions on the maximum amount or weightage of individual holdings within the asset mix. This helps ensure that no single company or security affects the fund’s performance excessively. Without such restrictions, fund managers may concentrate heavily on a few specific stocks. If those stocks perform poorly, investors may suffer substantial losses. Capped holdings prevent this from happening by limiting the concentration risk in the fund’s portfolio.
Disadvantages of capped funds
Before you choose to invest in capped funds, you should also be aware of their limitations, which include the following:
- Changes in the expense ratio: The cap on the expense ratio may change after you have invested in the fund. This could make the fund less suitable for your investment budget.
- Reduced flexibility: Due to restrictions on the fund’s holdings and investments, fund managers have reduced flexibility, which may, in turn, lead to missed opportunities in the market.
Key takeaways
- A capped mutual fund typically comes with a maximum limit on the fees it can levy each year.
- Some capped funds may have restrictions on the maximum weight of any particular asset or asset class in their portfolios.
- Caps on the expense ratio make investments cost-effective for investors, while caps on the weightage of individual investments help reduce the concentration risk.
Conclusion
Now that you know what a capped fund is and how it works, you can decide whether or not it is a suitable investment for you. If you want to invest in this type of fund or any other kind of mutual fund scheme, all you need to do is check out the 1,000+ funds available on the Bajaj Finserv Mutual Funds platform. Based on your financial goals and risk tolerance level, you can choose a fund and start a SIP in that scheme. You can also use the mutual fund calculator on this platform to make a smart investment choice.
