What are Hybrid Funds? You might be planning to start investing in mutual funds. Or looking to change your fund or asset type. But there are too many options. Where to invest? Is it low-risk debt or high-risk mutual funds? But what if you miss out on Gold? This is where hybrid funds come to the rescue. They hold multiple types of asset classes giving an optimum return to their investors while bringing down overall risk. We’ll learn in detail about hybrid funds in this article.
What are Hybrid Funds?
Hybrid Funds are types of mutual funds that hold different types of asset classes in their portfolio. They own equity, debt, gold, ETFs, derivatives, or other asset classes in various combinations according to the investment objectives laid down in their schemes. Diversifying asset classes helps bring down overall risk while staying open to various investment opportunities.
Different investors have different financial goals, risk appetites, and time horizons. Some investors are lookout for a fund type that can hold different types of investments. Hybrid mutual funds serve them better as they reduce the investor’s concern about holding multiple funds across different asset classes.
A hybrid fund follows a diversified approach thereby reducing the total beta. For example, stock prices fluctuate more than bond prices. Thus a hybrid fund owning both will have a lower beta or volatility and earn an adequate return simultaneously.
According to the needs of the investors, the fund industry offers various types of hybrid funds. The next section of our article talks about the different types of hybrid funds offered by asset management companies.
Types of Hybrid Funds
Broadly, there are seven types of hybrid mutual funds:
Multi-Asset Allocation Fund
Multi-Asset Allocation Hybrid Mutual Fund schemes have a minimum of three asset classes in their portfolio. It can be gold, equity, debt, real estate, etc. The fund manager must devote at least 10% of the fund’s assets to each such asset class. They increase or decrease the asset allocation per their outlook of different asset classes.
This scheme type allows the asset manager to hold multiple asset classes while giving a lot of flexibility at the same time.
Balanced Funds
Balanced Hybrid Funds invest in equity and debt both. Their allocation stays in the range of a minimum of 40% and a maximum of 60% for each asset class. These schemes are deemed as equity funds for tax purposes. Thus, tax is exempt on their long-term capital gains up to Rs 1 lakh.
Dynamic Asset Allocation or Balanced Advantage Fund
A Dynamic Asset Allocation or Balanced Advantage Hybrid Fund goes one step ahead in allowing more flexibility to the fund manager. S/he can allocate the entire 100% of the assets to debt or equity at any time they deem fit as per the landscape of financial markets.
This way investors can automate the allocation of their investment as per the judgment of the fund manager and the investment strategies of the fund.
Aggressive Funds
Aggressive Hybrid Funds typically allocate 65-80% of their assets in equity or equity equivalent instruments. The balance of the money goes into debt and the money markets. These funds are preferred by investors who want to have higher exposure to stocks but also have a debt component in their portfolios.
Conservative Funds
Conservative Hybrid Funds keep a majority of 75-90% of their assets in fixed-income instruments such as bonds, treasury bills, certificates of deposits, commercial papers, and other money market securities. The remaining funds are deployed in equity and equity-related securities. These schemes are ideal for risk-averse investors who want lesser volatility and steady returns.
Arbitrage Funds
These schemes try to maximize returns for their investors by making a profit from arbitrage opportunities. They purchase a security at a lower price in one market and sell the same at a higher price in another market. At any given point in time, an arbitrage fund’s gross exposure to equity is at least 65% of its assets. In the absence of arbitrage opportunities, the fund sits on cash or purchases debt securities.
Equity Savings Funds
These schemes invest in equity, debt, and derivatives to find an optimum balance between the returns earned and risk incurred. Such funds can allocate anywhere between 65 to 100% of their funds in equity and equity-related instruments. The rest is deployed towards debt. Making use of derivatives helps fund managers to hedge the overall risk and bring down directional exposure.
Benefits of Hybrid Funds
There are various benefits of investing in Hybrid Mutual Funds such as:
- Diversification: Owning multiple asset classes in one fund brings down the aggregate risk profile of the fund. This helps to balance the return earned by the investor as the lower or negative return of one asset class is offset against the better return from another asset class.
- Automated Balancing: Investors try to follow a balanced approach by owning funds across multiple asset classes. They shift funds and keep juggling between different fund types as per the state of the markets. A hybrid fund scheme helps to automate this for investors as the fund manager makes the same decision for their investors. They change the allocation between the asset classes when the market sentiment changes.
- Multiple Asset Classes: Holding low-beta assets such as gold stabilizes the overall returns of the funds making it ideal for novice investors who are well-versed in asset allocation and portfolio diversification.
- Active risk management: Investing in a hybrid fund allows active risk management as the fund managers are in a position quickly make changes to the portfolio. An investor holding multiple funds for different asset classes may delay making an informed decision for changing the allocation mix. This can result in significant losses to the investor.
Taxation of Gains from Hybrid Funds
The gains from Hybrid Funds are taxed in the following manner:
Equity component
- Long-term capital gains (LTCG) are exempt up to Rs 1 lakh. Above that, they are taxed at 10% without indexation.
- A tax of 15% is levied on short-term capital gains (STCG).
Debt component
The capital gains are taxed in a similar manner as a debt fund. The income is added to the investor’s regular income and taxed according to the applicable income tax bracket s/he falls into.
A 20% tax rate is levied on long-term gains from the debt component after the respective indexation benefit. It is 10% without indexation benefit.
In Conclusion
From what we read above, we can say that a hybrid fund seems to be an ideal choice for investors who want to reduce their allocation worries by holding different assets in the same fund. However, mutual funds don’t guarantee returns. An investor must assess market sentiment, the risk profile of the mutual fund, and his/her financial goals before investing in mutual funds.
In your opinion, are hybrid mutual funds a good investment alternative to other mutual funds? How about you tell us your views in the comments below?
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