Learn all about hybrid mutual funds

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Anisha Sinha (name changed), an early career management professional recalls that her foray into the world of mutual fund investments was marked by a lot of confusion and even misinformation. Sinha was intrigued about the power of mutual fund investments after hearing about it from her friends but it was only after a few months of trial and error that she figured that mutual fund investments offer way more flexibility than what is commonly perceived by novice investors.

Sinha narrates, “When I started investing in mutual funds, I used to think that equity mutual funds are the only way to go. It was only after a while that I came to know about debt mutual funds and hybrid mutual funds came into the picture for me even later. If I had known about hybrid funds earlier I would have reduced the weightage of equities in my portfolio because I was taking more risks than what I could stomach. Hybrid funds offer the best of both worlds – equities and debt.”

Hybrid funds offer investors a diversified portfolio because they typically invest in a mix of equities and bonds. These funds can have varying levels of risks ranging from low to moderate to even degrees that are palatable for the aggressive investors. The charm of investing in hybrid funds lies in the fact that these funds make it easier to achieve two goals – capital appreciation in the long term and higher return in the short term.

The equity component of hybrid funds facilitates capital appreciation and stability in the long run. Investment in debt instruments generates returns in the form of dividends and interests. What makes hybrid funds a worthy addition to your portfolio is that they provide higher returns than regular debt funds and are less risky than pure equities? Hybrid fund managers choose assets in such a manner so that the risks are balanced and the returns match the investment goals. Hybrid funds come in different varieties and here is a lowdown of the most common types of hybrid funds.

Types of Hybrid Funds

• Aggressive hybrid funds: An equity-oriented hybrid fund is one which invests at least 65% and a maximum of 80% of its total assets in equity and equity-related instruments across various market capitalizations and sectors and the remaining 35% is invested in debt securities and money market instruments.

• Conservative hybrid funds: These schemes invest 10 to 25 percent of their total assets in equity and equity-related instruments and the remaining 75 to 90 percent is invested in debt instruments. These funds are ideal if you are looking to generate income from the debt component of the portfolio while the equity component can catalyse overall returns in the long run.

• Equity savings fund: With equity savings fund, your investments will be divided between equity, debt, arbitrage and derivatives. This is a new mutual fund category under hybrid mutual funds and was introduced by SEBI in its mutual fund recategorization in 2017. The fund should invest a minimum of 65% of assets in equity, and a minimum of 10% in debt securities. Equity savings funds are considered safer than regular equity mutual funds and more tax efficient than regular debt funds. This is a suitable investment vehicle for investors with moderate risk appetites as fund managers can switch between various assets depending on market conditions to mitigate risks.

• Arbitrage funds: Fund managers of arbitrage funds buy stocks at a lower price in one market and sell it at a higher price in another and they constantly look for arbitrage opportunities to maximize the fund’s returns but there may be episodes when good arbitrage opportunities are not available. In such situations, investments are primarily made in debt securities and cash. Arbitrage funds are considered to be as safe as debt fund but the long-term capital gains are taxed like equity funds.

• Multi allocation asset funds: Multi-asset allocation funds are balanced mutual funds that invest at least 10% of their portfolio in three or more asset classes including investments in equity and debt market instruments, gold, real estate, and so on. This allows investors to reap the benefits of a diversified portfolio with the opportunity of capital appreciation in the long run. The taxation of capital gains of multi-asset allocation funds is based on the fund’s equity exposure. If the equity element exceeds 65%, the scheme is taxed like an equity fund and when the equity component is lesser, they are taxed like debt funds.

• Dynamic asset allocation funds: In these funds, investments are made in both equity and debt instruments and the allocations are changed depending on conditions of the stock markets and macroeconomic indicators. For instance, when valuations go up, the equity volume is reduced and valuations slide, the equity component is increased. These decisions are made by the fund managers and these funds can shift gears between 100 percent debt to 100 percent equity. Also, these funds carry higher risks than other hybrid fund.

• Balanced hybrid funds: These funds invest a minimum of 40 and a maximum of 60 percent in both equity and debt asset instruments. Arbitrage is not allowed in these funds.

Why you should invest in hybrid funds

Jitendra Agarwal, Founder of Jaipur-based Kukku Capital, an AMFI-certified mutual fund distributor explains, “Hybrid mutual funds schemes balance allocations across growth focused equity markets and income generating debt instruments and are suitable for creating inflation-adjusted positive returns over Bank FDR & Debt Mutual funds schemes with medium risk in the medium to long term. Hybrid schemes can be a good choice for investors to achieve short term & medium term goals & also for retirement planning if retirement is due in less than a decade.”

Sinha states “With time as I became more privy to the nuances if mutual fund investments I realized hybrid funds are a great way to access multiple asset classes through a single product instead of having to invest in multiple products for the sake of diversification. A positive trickle-down effect is that hybrid funds provide active risk management by investing in non-correlated asset classes like equity and debt. Also, for new entrants to the world of mutual fund investments, these funds offer convenience because they are spared of the trouble of having to actively track markets and rebalancing portfolios accordingly. The onus is on the portfolio manager who will inadvertently have more expertise to tweak the portfolio as and when required.”

It is not that the diversification is limited to investments under broad asset classes but investors can also dabble with various sub-classes within an asset class. For instance, your equity component can be spread across stocks of different categories of market capitalization. Also, there is something for everyone – whether you prefer to take the conservative route with your investments or feel undeterred by high risks, there are hybrid funds that can cater to various levels of risks.

Key takeways

• Calculate your tax liabilities before investing in a hybrid fund. The equity component of hybrid funds attracts taxes like equity funds. Long-term capital gains over Rs.1 lakh on equity component are taxed at the rate of 10% and the short-term capital gains (STCG) are taxed at the rate of 15%. Similarly, the debt component is taxed like debt funds – LTCG is taxable at 20% after indexation and 10% without the benefit of indexation.

• Hybrid schemes can be a good choice for investors to achieve short term & medium term goals & also for retirement planning if retirement is due in less than a decade.

• For new entrants to the world of mutual fund investments, these funds offer convenience because they are spared of the trouble of having to actively track markets and re balancing portfolios accordingly.

• Since hybrid funds come in various types, it is important to factor in your risk tolerance, financial goals, and investment horizon before choosing a scheme. If getting regular income is a priority, then a debt-oriented hybrid fund is a better choice whereas if your risk tolerance is on the higher side you can choose a more equity-heavy fund.

This article is part of the HT Friday Finance series published in association with Aditya Birla Sun Life Mutual Fund.


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