What are Hybrid Funds? A Comprehensive Guide for Investors

 



There are 155 schemes across seven categories of Hybrid Funds as of May 2024, shows Association of Mutual Funds in India (AMFI) data. Choosing the right category can be daunting for novice investors. This article will explore what are hybrid funds, their features, and much more.


A hybrid fund is a mutual fund that diversifies its investments across multiple asset classes, such as equity, debt, gold, silver and real estate/REITs. The investment objective of each hybrid mutual fund determines the specific asset allocation and proportion, aiming to balance risk and reward in line with the fund's strategy.

Key Features of Hybrid Funds

Diverse Asset Classes


Hybrid mutual funds allocate investments across various asset classes, offering greater diversification. This strategy reduces risk by being independent of the performance of a single asset class.


Balanced Portfolio


The allocation of different asset classes ensures a well-balanced portfolio. This makes hybrid funds suitable for investors with a moderate risk appetite, including those in their 40s who seek neither high-risk nor ultra-conservative investments.


Long-term Investment Potential


Hybrid funds are well-suited for medium to long-term investors, typically requiring a minimum investment horizon of four to five years. The fund's equity portion contributes to capital growth, while the debt portion provides stability and protects the downside.


Types of Hybrid Mutual Funds


Hybrid mutual funds can be categorized according to their asset allocation and investment strategy:


  1. Aggressive Hybrid Funds


  • Primarily invest in equities (65% to 80% investment in equity) and equity-related instruments.

  • The remaining portion (20% to 35%) is allocated to debt or money market instruments, balancing high growth potential and risk mitigation.


  1. Conservative Hybrid Funds


  • Focus on fixed-income instruments, such as bonds and government securities, with a minimum of 75% to 90% allocation in debt.

  • The remaining 10% to 25% is invested in equities to achieve capital appreciation.


  1. Arbitrage Funds


  • Aim to capitalize on price differences in different markets by buying in the cash market and selling in the futures market.

  • When arbitrage opportunities are limited, these funds can invest primarily in debt instruments.


  1. Balanced Hybrid Funds


  • They invest in 40% to 60% investment in equity & equity related instruments; and a the remaining in 40% to 60% in Debt instruments. 

  • This balance helps contain the risks associated with equity investments while aiming for capital growth.


  1. Equity Savings Funds


  • Invest in a combination of equity, derivatives, and debt instruments to hedge risky positions and reduce volatility.

  • Can be ideal for first-time MF investors who wish to participate in equities.


  1. Multi-Asset Allocation Funds


  • Invest in at least three asset classes: equity, debt, and often gold with at least 10% allocation to each asset class. 

  • This diversification helps protect against inflation, provides a hedge against market volatility and at the same time helps you participate in the upside potential of equities. 


  1. Dynamic Asset Allocation/Balanced Advantage Funds


  • Offer flexibility in asset allocation, allowing fund managers to adjust the balance between equity and debt dynamically.

  • This can range from 0% to 100% in  equity and debt. 


Functioning of Hybrid Funds


Hybrid funds invest in a blend of asset classes to create a balanced portfolio. For example, a typical combination of equity and debt:


  • Equity Component: Drives capital appreciation, contributing to the portfolio's growth potential.

  • Debt Component: Provides stable returns and cushions the portfolio against market volatility.


The interplay between equity and debt, with their lower correlation, makes the overall portfolio more stable and reduces risk compared to investing in a single asset class.


Who Should Invest in Hybrid Funds?


Hybrid funds are versatile, catering to diverse types of investors:


  • New Investors: Suitable for those new to mutual funds, offering a balanced approach with low to medium risk and providing exposure to the equity market.

  • Medium-term Investors: Ideal for those with an investment horizon of three to five years, offering lower volatility than pure equity funds.

  • Retirees: Debt-oriented hybrid funds provide stable returns with low volatility, making them suitable for retired individuals seeking consistent income.

  • Short-term Investors: Arbitrage or conservative funds are appropriate for investors looking to park their funds.


Taxation of Hybrid Funds


The tax implications for hybrid funds depend on their asset composition:


Equity-Oriented Schemes


  • Long-Term Capital Gains (LTCG): Gains arising from investments of over one year are taxed at 10% without indexation, above Rs. 1 lakh per financial year.

  • Short-Term Capital Gains (STCG): Gains held for less than one year are taxed at 15%.


Other Schemes (Non-Equity Oriented)


  • Purchased before April 1, 2023:

    • LTCG: Gains held over three years are taxed at 20% with indexation benefits.

    • STCG: Gains held for less than three years are added to the income and taxed at applicable slab rates.

  • Purchased after April 1, 2023:

    • All gains, irrespective of the holding period, are considered short-term and taxed at applicable slab rates without indexation benefits.


Conclusion


These plans combine equity, debt, and other asset classes based on risk tolerance and investment goals. With their balanced nature, hybrid funds suit many investors, from first-time to retirees. Always review the scheme's Key Information document and the investment objective to make an informed decision before investing.

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