As the name suggests, hybrid funds are mutual funds that invest in different types of asset classes. There are different types of hybrid funds that invest in equities as well as debt in different proportions. Hybrid funds invest in varied asset classes to offer optimised diversification and minimise risks associated with any one type of asset class. The kind of hybrid fund you should invest in would depend on the asset allocation mix it has.
Different types of hybrid funds
Hybrid funds can be differentiated by their allocation to equity and debt. Some types of hybrid funds have a higher allocation equity, while some to debt. Let’s look at them in detail.
These are the most popular type of hybrid funds. Balanced funds invest at least 65% of their portfolio in equity and equity-oriented instruments. This allows them to qualify as equity funds for the purpose of taxation, which means that gains from balanced funds held for a period of over 1 year become completely tax-free. The rest of the fund’s assets are invested in debt securities and some amount might also be kept in cash. Balanced funds are ideal investments for conservative investors who wish to benefit from the return-earning capacity of equities without taking too much risks. The fixed income exposure of balanced funds helps in mitigating equity-related risks.
Monthly income plans
These are hybrid funds that invest predominantly in debt instruments. A monthly income plan (MIP) would generally have 15-20% exposure to equities. This would allow it to generate higher returns than regular debt funds. MIPs provide regular income to the investor in the form of dividends. An investor can choose the frequency of dividends, which can be monthly, quarterly, half-yearly or annually. These options are available in the dividend option. MIPs also come with the growth option that doesn’t pay out a dividend but lets the investments grow in the fund’s corpus. Hence, MIPs should not be treated as a monthly income investment. The name can be misleading to new investors. Consider MIPs to be hybrid funds that invest mostly in debt and some amount in equities.
Arbitrage funds are equity-oriented mutual funds that try to take advantage of the mispricing in the price of a stock between the derivatives market and futures market. The fund manager looks for such opportunities to maximise returns by buying the stock at a lower price in one market and selling it at a higher price in another market. By design, arbitrage funds are relatively safe funds. They also enjoy the tax efficiency of equity funds and long-term returns earned from them are tax-free. However, arbitrage opportunities are not always available easily. In the absence of arbitrage opportunities, these funds might stay invested in debt instruments or cash. This is why they can be considered to be hybrid funds.
These are the popular types of hybrid funds. Some fund companies offer different hybrid funds as well. There are hybrid funds specially for children’s education or retirement. These are funds that are offered with a preset goal-orientation. Understand the asset allocation they offer carefully before you invest in them.