Mutual funds are of three types based on asset allocation – equity, debt, and hybrid funds. Investors looking for a middle ground in terms of risk and rewards can ideally go for hybrid mutual funds due to the balance these funds offer. It is recommended that investors pick an investment category based on their financial goals, time horizon and risk tolerance.
Hybrid mutual funds invest in a combination of debt and equity instruments to meet specific predetermined objectives. These funds come with varying risk factors, returns, etc., helping target a diverse range of investors.
This is possible due to diverse corpus allocation, which helps to mitigate portfolio risk. Moreover, fund managers of hybrid mutual fund schemes assess market conditions and buy/sell securities to achieve the scheme’s objectives in the best possible manner.
Hybrid mutual funds are a safer option in comparison to equity-based mutual funds due to their exposure to debt instruments. As a result, these are suitable for investors who are looking to safeguard their portfolios from market volatility. If you are looking for equity exposure with reduced risk, hybrid mutual funds are a suitable option.
Also Read: What Is ESIP?
There are seven types of hybrid mutual funds, categorized based on their asset allocation. Let’s have a look at some of them
As per SEBI, these funds must invest in at least three asset classes with a minimum of 10% for each of them. As a result, investors get sufficient exposure to different types of financial instruments.
In the case of balanced hybrid funds, fund managers need to invest a minimum of 40% and a maximum of 60% of the corpus in both debt and equity classes. This is to generate long-term capital generation alongside mitigating market risks courtesy of the debt instruments. Arbitrage is not allowed in balanced hybrid funds.
These hybrid mutual funds allocate a minimum of 65% and a maximum of 80% of the fund corpus to equity and equity-related instruments. Moreover, such mutual fund schemes invest 20%-35% of the pooled funds in debt securities to hedge portfolio risks and generate stable income.
Also known as balanced advantage funds, these are truly dynamic schemes that can switch between 100% equity to 100% debt instruments. Fund managers of these schemes do the asset allocation based on the fund’s financial model. Such funds are suitable for investors looking to automate their asset allocation.
These schemes require investing 10% – 25% of the corpus in equity and equity-related instruments. The rest, 75% – 90%, is invested in debt instruments. These funds can generate stable income as their portfolio primarily comprise debt securities. That said, the equity components boost the overall returns in the long run. Hence, these are ideal if you are looking for stable returns without taking too much risk.
These funds strike a balance between risk and returns through investments in equity, debt, and derivatives. Derivatives help combat volatility and provide stable returns by reducing directional equity exposure. As per SEBI regulations, these funds must invest a minimum of 65% of the fund corpus in stocks and at least 10% in debt instruments.
Arbitrage funds aim to generate returns for investors by taking advantage of the price difference in the derivatives market and the cash market. In other words, arbitrage fund managers buy equity at a lower price in one market and sell them at a higher price in another market.
Fund managers of these schemes are always on the hunt for arbitrage opportunities to maximise returns in accordance with scheme objectives. That being said, these windows of opportunity are not always easy to come by. During such times, arbitrage fund managers increase their asset allocation in debt instruments. This makes them a safer bet than equity funds.
The advantages of investing in hybrid mutual funds are multifold. These are:
Hybrid funds offer schemes with high risks to medium and low-risks alongside. This gives you and other investors to choose a scheme as per your risk appetite to fulfill your investment goal.
2. Exposure to Multi-asset Classes
Since hybrid funds invest in both debt and equity instruments, you can get exposure to more than one asset class when investing in this type of mutual fund scheme.
3. Prudent Risk Management
Hybrid fund managers actively manage the funds by investing in a mix of non-correlated assets to hedge portfolio risks. This reduces portfolio risk significantly in the long term and helps generate maximum returns.
4. Investment in Asset Subclasses
Hybrid fund managers also have the leeway to invest in different asset subclasses from a category as well. For example, while investing in equity class, they can choose from large/mid/small-cap stocks to meet the scheme’s objectives.
1. Asset Allocation: Fund managers require allocating assets of hybrid funds depending on the type of fund.
2. Types: Equity and debt-oriented funds are further segregated into aggressive hybrid mutual funds, balanced advantage funds, conservative hybrid funds, and multi-asset allocation funds.
3. Risk-Reward Ratio: Fund managers minimise portfolio risks by investing in a combination of assets having low correlation. This results in diverse asset allocation and reduces associated risk with each asset class.
The taxation of equity-oriented hybrid funds is the same as equity funds. Long-term capital gains (LTCG) attract 10% tax. That said, a tax rate of 15% is applicable on short-term capital gains. Remember, LTCG of up to Rs. 1 lakh is tax-free.
In the case of debt-oriented hybrid funds, short-term capital gains are added to investors’ taxable income and are taxed as per the income tax slab rate. On the other hand, long-term capital gains attract 20% tax. Moreover, investors are eligible for indexation benefits.
On the other hand, debt components are taxed like debt funds. All short-term capital gains are taxed as per your income tax slab rate. Long-term capital gains are taxable at a flat 20% rate with indexation benefits and 10% without indexation benefits.
Note: For equity funds, short-term capital gains are returns from an investment held for less than a year. Long-term capital gains are income from investments held for more than one year.
Whereas, for debt funds, short-term capital gains are returns from an investment held for less than three years. Long-term capital gains are income from investments held for more than three years.
If you want to invest in hybrid mutual funds, here are a few things you should consider as a potential investor:
Hybrid mutual funds come with the cushion of regular income from debt instruments while making aggressive moves in equity assets for higher returns. This means there are certain associated risks that you need to consider before investing.
Hence, checking a fund’s past performance along with other vital aspects is necessary to gauge the fund’s ability to generate returns in varying market conditions.
Ans: Debt instruments are assets that offer a fixed payment to the holder along with interest. This does not change despite market conditions or other factors and is a binding obligation. A few examples of debt instruments include bonds, debentures, treasury bills, promissory notes, etc.
Ans: No, hybrid funds do not come with a lock-in period. Investors may redeem their units anytime they want.
Ans: A derivative is a contract between two or more parties, the value of which is based on a mutually agreed-upon financial security, asset, or index.
Ans: There is no readymade solution when it comes to investing in hybrid funds. Individuals might want to consider deciding the investment duration after identifying their financial goals.
Ans: The exit load is a fee that an AMC (asset management company) imposes on investors if they exit a scheme before a pre-specified period. Hybrid funds may or may not levy exit load. Make sure to read the scheme-related documents before investing to know whether the fund imposes this charge.
Ans: When it comes to investing in hybrid funds, there is no ideal time. you can choose to invest in a hybrid fund scheme whenever you wish to. Also, make sure to stay invested for as long as possible to reap the benefits of the power of compounding.
Mutual funds are of three types based on asset allocation – equity, debt, and hybrid funds. It is recommended that investors pick an investment category based on their financial goals, time horizon and risk tolerance. Investors looking for a middle ground in terms of risk and rewards can ideally go for hybrid funds due to the balance these funds offer.
Ans: Conservative funds are a type of hybrid fund that carry relatively low risks. In these types of funds, the portfolio consists of debt and equity securities. Typically, these funds invest around 75% to 90% in debt securities. Whereas, 10%-25% of investments are made in equity and equity-related investments. This will increase the chances of better returns than just investing in pure debt funds.
Ans: Most investors and fund managers consider hybrid funds to be a safer option compared to equity funds. Debt-oriented hybrid funds tend to provide higher returns than conservative debt funds and are popular among investors with low risk appetite.
If you are a beginner at investing but also want to get higher returns without much risk, you may consider investing in hybrid funds.
Ans: Aggressive mutual funds are just the opposite of conservative funds. In this case, the majority of the investments are made in equity and equity-related instruments as compared to debt-oriented funds. Usually, 65%-80% of their total assets are invested in equity instruments and 20%-35% in debt securities.
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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