Hybrid funds: Meaning, types and benefits

Hybrid mutual funds combine equity and debt investments within a single portfolio, offering a diversified approach. This structure aims to capture the long-term growth potential of equities while incorporating debt instruments for a degree of relative stability. For Indian investors looking for a balanced investment strategy, hybrid funds can be a suitable choice. These funds accommodate different risk levels and financial goals, acting as a middle ground between pure equity and pure debt options. Understanding their types and key features is essential for informed investment decisions. This article will discuss the meaning, types, and potential benefits of hybrid mutual funds in India, helping investors navigate these flexible investment options.

• Table of contents

• What are hybrid funds?
• How a hybrid mutual fund works
• Features of hybrid funds
• What are the types of hybrid mutual funds?
• Benefits of hybrid mutual funds
• Taxation rules of hybrid mutual funds

What are hybrid funds?

Hybrid funds are investment vehicles that combine the features of both equity and debt funds. These funds offer a diversified portfolio to investors by investing in a mix of stocks and fixed-income securities like bonds and treasury bills. The primary objective of hybrid mutual funds is to provide a relatively reasonable return potential while managing risk.

Investing in hybrid mutual funds can be an attractive option for investors seeking a balanced approach to wealth generation. These funds aim to strike a harmonious balance between the growth potential of equities and the stability of fixed-income instruments. By diversifying across asset classes, hybrid funds can potentially reduce the overall risk in your investment portfolio.

How a hybrid mutual fund works

Hybrid mutual funds allocate investments between equity and debt. The ratio of debt-equity depends upon the fund category and the investment approach. For instance, aggressive hybrid fund has a higher equity allocation to enhance potential long-term returns, whereas a conservative hybrid fund focuses more on debt to reduce fluctuations. Fund managers can adjust the portfolio’s composition (while maintaining mandatory limits) in response to market conditions and the fund’s investment strategy. Effective asset allocation by the fund manager plays a key role in managing risk and optimizing potential gains.

The equity component seeks to generate potential capital appreciation in the long term. The debt component aims to provide relatively steady return potential and mitigate the impact of volatility.

Fund managers may rebalance allocations periodically to maintain the target allocation ratio.

The performance of hybrid funds is influenced by both equity and debt market trends.

Features of hybrid funds

Hybrid funds offer several characteristics for investors:

• Active management: Professional fund management eliminates the need for investors to decide asset distribution.
• Range of options: Different hybrid fund types cater to varying investment objectives and risk preferences.
• Risk considerations: Hybrid funds generally carry a moderate to very high risk, depending on their equity allocation. Funds with over 65% equity exposure fall under the very high risk category.

These features make hybrid funds a flexible investment option for individuals looking to balance risk and potential wealth creation.

What are the types of hybrid mutual funds?

There are several types of hybrid funds, each tailored to meet different investment objectives and risk profiles. Here's a breakdown of the common types of hybrid funds:

• Aggressive hybrid funds: These funds have a higher allocation to equities, making them suitable for investors with a higher risk tolerance. They typically invest around 65-80% in equities, with the rest in debt instruments.
• Conservative hybrid funds: For those looking for a relatively stable investment avenue, conservative hybrid funds can be suitable. They allocate a larger portion of their portfolio, around 75-90%, to debt securities, and the remainder to equities.
• Balanced hybrid funds: These funds almost evenly divide their portfolios between debt and equity, allocating between 40% and 60% of their total assets to each. They provide moderate growth potential with relatively lower risk.
• Dynamic asset allocation funds: These funds have the flexibility to adjust their equity and debt allocations based on market conditions. They aim to capitalise on market opportunities while managing risk.
• Arbitrage funds: These funds primarily invest in arbitrage opportunities between the cash and derivative markets. They offer relatively lower risk and are often used for short-term investments.
• Multi-asset allocation funds: These funds diversify their portfolio by investing in various asset classes, including equities, debt, and sometimes even commodities and real estate, providing a broader investment spectrum.

The simple answer to the question ‘What is a hybrid mutual fund’ is that these funds offer investors a versatile choice to achieve their financial goals with a blend of asset classes. However, it's essential to assess your risk tolerance and investment objectives before choosing a specific type of hybrid fund. Consulting a financial advisor or distributor can help you make informed investment decisions tailored to your unique financial situation.

Also Read: How to invest in liquid funds

Benefits of hybrid mutual funds

Hybrid mutual funds can be a suitable option for Indian investors looking for a balanced investment strategy, offering several potential advantages.

• Diversification: Investing in both equity and debt can potentially reduce overall portfolio volatility. This diversification helps cushion the impact of market fluctuations on any single asset class.
• Professional management: Fund managers actively handle asset allocation, adjusting it based on market conditions and the fund’s objectives. This can be beneficial for investors who may not have the time or expertise to manage their portfolios.
• Flexibility: A variety of hybrid funds, ranging from conservative to aggressive, allow investors to choose options that match their risk tolerance and financial goals.
• Potential for capital appreciation and income: These funds aim to provide potential capital growth through equity investments while offering relatively stable income through debt holdings.
• Convenience: A single hybrid fund provides exposure to multiple asset classes, simplifying portfolio management.

Taxation rules of hybrid mutual funds

The tax treatment of hybrid mutual funds in India depends on the proportion of equity in the fund’s portfolio.

Equity-oriented hybrid funds (more than 65% equity allocation):

• Taxed like equity mutual funds.
• Long-term capital gains (LTCG) exceeding Rs. 1.25 lakh in a financial year are taxed at 12.5%.
• Short-term capital gains (STCG) are taxed at 20%.

Debt-oriented hybrid funds (less than 65% equity allocation):

• Taxed like debt mutual funds.
• Capital gains are added to the investor’s income and taxed based on applicable income tax slab rates.

Read Also: How to invest in debt funds?

Conclusion

Hybrid mutual funds offer Indian investors a flexible way to build a diversified portfolio. By blending equity and debt, they seek to balance potential growth with relative stability. Understanding their different types and features is key to making well-informed investment choices. Factors such as risk tolerance, investment objectives, and taxation should be carefully evaluated. While hybrid funds provide advantages like diversification and professional management, they still carry investment risks. Conducting thorough research and seeking expert advice can help investors make better decisions. Hybrid funds can be a suitable long-term investment tool, but they require a well-planned approach.

FAQs

What is a hybrid mutual fund?

A hybrid mutual fund invests in a combination of equity and debt instruments. This mix is designed to balance potential long-term growth with relatively steady returns. The proportion of equity and debt varies based on the fund's objective and risk profile, providing investors with a diversified investment approach.

How does a hybrid fund work?

Hybrid funds distribute investments between equities and debt, adjusting the allocation based on market trends and the fund’s strategy. The equity portion aims for potential capital appreciation in the long term, while the debt portion seeks relatively stable returns. Fund managers actively manage these allocations to align with the fund’s objectives.

What are the risks of investing in a hybrid fund?

Hybrid funds are exposed to risks from both equity and debt markets. The equity portion is affected by market fluctuations, while the debt component is subject to interest rate and credit risks. The overall risk level depends on the fund’s equity-debt mix, with funds holding more than 65% in equities requiring a high risk appetite.

Is it safe to invest in hybrid funds?

No mutual fund is safe. The risk level of hybrid funds varies based on the fund’s allocation strategy. Equity-oriented hybrid funds carry high risk while debt-oriented mutual funds may carry moderate risk. Investors should carefully evaluate their risk tolerance before investing.

Are hybrid mutual funds tax free?

No, like all mutual funds, hybrid funds are subject to taxation. If a hybrid fund has more than 65% allocation to equity, it is taxed similarly to equity funds. Those with a higher debt allocation are taxed according to the investor’s income tax slab. Tax treatment depends on the asset mix and the holding period.

Is hybrid fund good for long-term investment?

Hybrid funds can be suitable for long-term investments due to their diversified nature. They offer potential capital appreciation in the long term from equities and relatively steady return potential from debt. However, their suitability depends on an investor’s financial goals and risk tolerance. Holding them long-term may help manage market fluctuations.

How do I choose a hybrid fund?

Selecting a hybrid fund requires assessing your risk appetite, investment objectives, and time horizon. Identify a category that aligns with these factors. Evaluate the fund’s asset allocation, historical performance*, and expense ratio. Consider the fund manager’s expertise and investment strategy.

Past performance may or may not be sustained in future.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.