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Mutual fund investors can be broadly classified into three categories. One, those who are ready to take some risk and they invest in equity funds. Second, those who play it safe by investing in debt funds that assures some returns while keeping money safe, and third, those who want the best of both, by going for hybrid funds. This article covers the following:
Hybrid funds invest in both debt and equity instruments to achieve diversification and avoid the concentration risk. A perfect blend of the two offers higher returns than a regular debt fund while not being as risky as equity funds. The choice of a hybrid fund depends on your risk preferences and investment objective.
Hybrid funds aim to achieve wealth appreciation in the long-run and generate income in the short-run via a balanced portfolio. The fund manager allocates your money in varying proportions in equity and debt based on the investment objective of the fund. The fund manager may buy/sell securities to take advantage of market movements.
Hybrid funds are considered a safer bet than equity funds. These provide higher returns than genuine debt funds and are popular among conservative investors. Budding investors who are willing to get exposure to equity markets may invest in hybrid funds. The presence of equity components in the portfolio offers the potential to earn higher returns.
At the same time, the debt component of the fund provides a cushion against extreme market fluctuations. In this way, you receive stable returns instead of a total burnout that may happen in case of pure equity funds. For the less conservative category of investors, the dynamic asset allocation feature of some hybrid funds becomes a great way to enjoy the best out of market fluctuations.
Hybrid funds are further classified based on their asset allocation. Some hybrid funds have a higher equity allocation, while others allocate more towards debt. Let’s have a look in detail:
a. Equity-oriented hybrid funds
If the fund manager invests more than 65% of the fund’s assets in equity and the rest in debt and money market instruments, then it’s called an equity-oriented fund. The equity component of the fund comprises of equity shares of companies across industries such as FMCG, finance, healthcare, real estate, automobile, and so on.
b. Debt-oriented balanced funds
A hybrid fund is termed as a debt-oriented fund if the fund manager allocates more than 65% towards debt instruments. The debt component of the fund constitutes the investment in fixed-income havens such as government securities, debentures, bonds, treasury bills, and so on. For the sake of liquidity, some part of the fund would also be invested in cash and cash equivalents.
c. 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. Investors can choose the frequency of dividends payout; it can be monthly, quarterly, half-yearly, or annually.
MIPs also come with the growth option – they let the investments grow in the fund’s corpus. Hence, an MIP is not a small monthly income investment. Do not let the name mislead you. They are hybrid funds that invest mostly in debt and some amount of equities.
d. Arbitrage Funds
An arbitrage fund manager tries to maximise returns by buying the stock at a lower price in one market. He then sells it at a higher price in another market.
However, arbitrage opportunities are not always available quickly. In the absence of arbitrage opportunities, these funds might stick to debt instruments or cash. By design, arbitrage funds are relatively safer, like most debt funds. But its long-term capital gains are taxable like that of any equity fund.
a. Risk factor
It would not be wise to assume hybrid funds to be completely risk-free. Any instrument which invests in equity markets will have some risk. It might be less risky than pure equity funds, but you need to exercise caution and portfolio rebalancing regularly.
Hybrid funds don’t offer guaranteed returns. The performance of underlying securities affects the Net Asset Value (NAV) of these funds. So, it may fluctuate due to market movements. Moreover, these might not declare dividends during market downturns.
Hybrid funds would charge a fee for managing your portfolio, which is known as the expense ratio. Before investing in a hybrid fund, ensure it has a low expense ratio than other competing funds, and this translates into higher take-home returns for the investor.
d. Investment Horizon
Hybrid funds may be ideal for a medium-term investment horizon, say five years. If you want to earn a risk-free rate of return, you may go for arbitrage funds. They bet on price differentials of securities in different markets.
e. Financial Goals
You can meet intermediate financial goals like buying a car or funding higher education with hybrid funds. Retirees too invest in balanced funds and go for a dividend option to supplement their post-retirement income.
f. Tax on Gains
The equity component of hybrid funds is taxed like equity funds. Long-term capital gains over Rs.1 lakh on equity component are taxed at the rate of 10%. Short-term capital gains (STCG) on equity component are taxed at the rate of 15%.
The debt component of hybrid funds is taxable as any other debt fund. You must add these gains to your income and taxed as per your income slab. LTCG from debt component is taxable at 20% after indexation and 10% without the benefit of indexation.
You can invest in hybrid funds in a paperless and hassle-free manner at ClearTax. Using the following steps, you can start your investment journey:
1: Sign up for an account at cleartax.in
2: Provide all the requested details
3: Get your e-KYC done, this can be completed in less than 5 minutes
4: Invest in your preferred hybrid fund from amongst the hand-picked mutual funds
While selecting a fund, you need to analyse the fund from various perspectives. Various quantitative and qualitative parameters can tell you which is the best hybrid fund that suits you. Additionally, you need to keep your financial goals, risk appetite, and investment horizon in mind.
The following table shows the top five balanced funds in India based on the past three year returns.
|Fund name||3-year returns||Link|
|Mirae Asset Hybrid-Equity Fund||11.64%||Invest Now|
|ICICI Prudential Advisor Series – Conservative Fund||10.56%%||Invest Now|
|Motilal Oswal Dynamic Fund||9.60%||Invest Now|
|SBI Equity Hybrid Fund||9.60%||Invest Now|
|ICICI Prudential Balanced Advantage Fund||9.50%||Invest Now
*The order of funds doesn’t suggest any recommendations. Investors may choose the funds as per their goals. Returns are subject to change.