What Are Hybrid Mutual Funds and Why You Should Invest in Them?
Do Hybrid Funds really add value to your portfolio? Why exactly should an investor be investing in Hybrid funds and which hybrid funds to select?
What is a Hybrid Fund all about?
Hybrid mutual funds, as the name suggests, are a category of mutual funds that invest in a combination of asset classes such as equity and debt as well as other asset classes like gold and derivative products. Hybrid funds are broadly high on the risk scale compared to pure equity funds and lower on the risk scale compared to pure debt funds.
Typically, a pure equity fund or a pure debt fund tends to be focussed on a particular asset class or theme. Typical equity themes are large cap, mid-cap, small cap, value etc. Common debt themes are credit risk, corporate bonds, G-Secs, Long Duration etc. Hybrid funds invest in equity stocks and bonds in varying proportions as per the objectives of the fund.
When to select which Hybrid Fund?
Broadly there are 7 classes of hybrid funds and let us look at when to select each of these hybrid funds and to whom would it suit well.
| Category of Hybrid Funds | Description of the fund | Whom does it suit? |
| Balanced Hybrid Funds | They approximately balance their holdings in equity and debt. Typically, the equity and debt components in these funds range between 40% and 60%. So a balanced fund can be 40% in equity and 60% in debt or vice versa or it can be any combination in between. | Suited to investors who want to combine debt and equity but based on a passive formula |
| Conservative Hybrid Funds | These funds normally invest between 10% and 25% of the total corpus in equity and the balance 75-90% in debt. That is why they are called conservative as they are predominantly debt funds with a small part of the corpus in equities. Funds combine steady income with some alpha. | Suited to investors who are conservative but willing to bear some risk for alpha to gain higher returns. |
| Aggressive Hybrid Funds | These funds are exact opposite of conservative hybrids. Aggressive hybrid funds will have between 65-80% in equity and the balance in debt. This small component of debt gives some stability to the predominant equity exposure. Returns are higher but risk is also higher | This is good for typical bond investors looking to get into equity. It makes the transition smooth |
| Arbitrage Funds | Arbitrage Funds are treasury products due to the mix of equity, futures and debt. Arbitrage funds buy a stock in the equity market and sell equivalent futures in the F&O market so that premium on futures is locked as assured profits. Equity holdings will be above 65% and the balance in futures margins with positive spread so it is equity for tax purposes. | This is a treasury product and used to park any kind of temporary surplus at better than savings bank returns |
| Equity Savings Funds | Equity Savings Funds are a combination of equity, debt and futures & options and are an extension of the arbitrage fund. The only difference is that these are not treasury products but they use futures to enhance returns. These are again equity funds as per the tax levy classification. | This is for slightly more risk taking investors as it also entails leverage of futures in lieu of equity |
| Multi-Asset Allocation Funds | These funds are not too common in India but they combine at least 3 asset classes into a single fund. For example, equity, debt and gold is a classic combination of a multi-asset allocation fund with predominant focus on any one of them. Each must be minimum 10%. | This gives added advantage of diversification across multiple asset classes |
| Dynamic Asset Allocation Funds | This category is extremely popular after the record NFO collections of SBI BAF. These are based on discretion of the fund manager and the allocations can go from 0% to 100% in debt and from 0% to 100% in debt. in practice, most of the BAFs do keep a bare minimum in both asset classes as matter of internal policy. | This is suited to investors who are willing to give more of discretion powers to the fund manager. |
Are there any distinct advantages of investing in Hybrid Funds?
Almost all mutual funds are essentially hybrid funds as most of the equity funds also hold some portion in debt for liquidity and stability. Here are some key merits of investing in a hybrid fund.
-
Hybrid funds permit a clever balance of Risk and Return. In fact, the beauty is that the investor can define the risk-reward ratio and accordingly choose a hybrid fund that best fits into that risk-reward ratio.
-
At the time of asset allocation, some portion of the allocation can be left to hybrid funds and only the balance needs to be actively allocated. This makes your task of allocation and monitoring much easier.
-
There is a wide palate to choose from including aggressive funds, conservative funds, formula funds, virtual assured return funds etc. Investors have the leeway to choose based on their preference matrix.
-
Hybrid funds can be designed in such a way that they fit well into Bull and Bear Markets. This happens by combining assets with low correlation which do not move with the crowd, so in either extremes, the overall risk is quite low.
-
These funds are apt for new investors and first time investors as it gives exposure to equity, debt and other asset classes without sharpening the risks too much. This ensures better risk adjusted returns.
-
Hybrid funds are convenient as instead of managing multiple funds, handling allocations and rebalancing, you just focus on one fund that does all this for you and that too on auto mode.
-
Above all, these hybrid funds give fund managers the flexibility to invest the funds collected as per the set objectives of the fund. They can tweak exposures based on the market conditions.
Can Hybrid Funds be a better tax play?
That is true in a way. Aggressive Balanced funds with a minimum exposure of 65% to equities are classified as equity funds. This gives them preferential treatment in terms of taxation of capital gains. Today dividends on equity funds and debt funds are all taxed at the peak rate of the investor, so there is not much of a difference. However, it is about capital gains.
Capital gains on a debt fund are classified as short term if it is held for less than 3 years and taxed at your peak rate. If you hold the debt funds beyond a period of 3 years then it becomes long term capital gains and is taxed at 20% with the benefit of indexation. What about equity funds?
In the case of equity funds, capital gains are treated as long term if held for more than 1 year. In case of equity funds, short term gains are taxed at 15% while long term gains are taxed at just 10% and that too after a basic exemption of Rs.1 lakh per year.
A final word on hybrid funds. The choice is wide and you can make those small tweaks to create combinations that perfectly suit your unique needs. Essentially, hybrids mix and match the two extremes of equity and debt to give you that added advantage in the financial markets. In the process, you end up managing your journey towards your goals a lot better and also more efficiently.