1. How do Hybrid Funds work?
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 investment objective of the fund. Hybrid funds can be equity-oriented or debt-oriented.
When the fund manager invests 65% or more of the fund’s assets in equity and rest in debt and money market instruments, it’s called an equity-oriented fund. Conversely, an asset allocation of 60% or more in debt and rest in equity is called a debt-oriented fund. For the sake of liquidity, some part of the fund would also be invested in cash and cash equivalents.
The equity component of the fund comprises of equity shares of companies across industries like FMCG, finance, healthcare, real estate, automobile, etc. The debt component of the fund constitutes the investment in fixed-income havens like government securities, debentures, bonds, treasury bills, etc. The fund manager may buy/sell securities to take advantage of market movements.
2. Who should Invest in Hybrid Funds?
Hybrid funds are regarded as safer bets than pure equity funds. These provide higher returns than pure debt funds and are a favourite among conservative investors. Budding investors who are eager to take exposure in equity markets can think of hybrid funds as the first step. As these are an ideal blend of equity and debt, the equity component helps to ride the equity wave.
At the same time, the debt component of the fund provides a cushion against extreme market turbulence. In that way, you receive stable returns instead of a total burnout that might be possible 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 milk the maximum out of market fluctuations.
3. Types of Hybrid Funds
Hybrid funds can be differentiated as per their asset allocation. Some types of hybrid funds have a higher equity allocation while others allocate more to debt. Let’s have a look in detail.
a. Balanced Funds
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. It means that gains over and above Rs 1 lakh from balanced funds held for a period of over 1 year are taxable at the rate of 10%.
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 many risks. The fixed income exposure of balanced funds helps in mitigating equity-related risks.
b. 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 mere 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 of equities.
c. Arbitrage Funds
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.
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. By design, arbitrage funds are relatively safer funds. They are treated like equity funds as regards taxability and long-term returns earned from them are taxable.
Some fund houses offer hybrid funds especially for children’s education or retirement. These funds are offered with a preset goal-orientation. Understand the asset allocation carefully before you invest in them.
4. Things an Investor should consider
It would be unwise to assume hybrid funds to be completely risk-free. Any instrument which invests in equity markets will have some kind of 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 affect Net Asset Value (NAV) of these funds and 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. This translates into higher take-home returns for the investor.
d. Investment Horizon
Hybrid funds may be ideal for a medium-term investment horizon of say 5 yrs. If you want to earn a risk-free rate of return, you may go for arbitrage funds which bet on price differentials of securities in different markets.
e. Financial Goals
Hybrid funds may be used for intermediate financial goals like buying a car or funding higher education of one’s own. Retirees may 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 in excess of Rs 1 lakh on equity component are taxed at the rate of 10%. Short-term capital gains on equity component are taxed at the rate of 15%.
The debt component of hybrid funds is taxed as debt funds. STCG from debt component is added to the investor’s income and taxed according to his income slab. LTCG from debt component is taxed at the rate of 20% after indexation and 10% without the benefit of indexation.
5. How to Invest in Hybrid Funds?
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:
Step 1: Sign up for an account at cleartax.in
Step 2: You need to enter your details like the amount of investment and investment period
Step 3: Get your e-KYC done in less than 5 minutes
Step 4: Invest in your favourite hybrid fund from amongst the hand-picked mutual funds
6. Top 5 Hybrid Funds in India
While selecting a fund, you need to analyse the fund from different angles. There are various quantitative and qualitative parameters which can be used to arrive at the best hybrid funds as per your requirements. Additionally, you need to keep your financial goals, risk appetite and investment horizon in mind.
The following table represents the top 5 balanced funds in India based on the past 5 year returns. Investors may choose the funds based on a different investment horizon like 10 years returns. You may include other criteria like financial ratios as well.
|Fund Name||1 year||3 year||5 year|
|Tata Retirement Savings Fund - Moderate Plan||14.95||11.68||20.87|
|HDFC Balanced Fund||11.21||10.51||19.42|
|L&T India Prudence Fund||10.71||10.19||19.2|
|Principal Balanced Fund||17.97||13.57||18.35|
|ICICI Prudential Balanced Fund||8.93||10.55||18.31|
*The order of funds doesn’t suggest any recommendations. Investors may choose the funds as per their goals. Returns are subject to change.