What are Hybrid Mutual funds

Confused about what is better for your equity funds or debt funds? Why not get the best of both worlds with Hybrid mutual funds.

Hybrid Mutual Funds, also known as Balanced Funds, are a type of mutual fund that invests in both stocks and bonds. They provide the benefits of both stocks and bonds in one investment.

Hybrid Mutual Funds are an attractive investment option for investors who want to take advantage of the growth potential of stocks but also want to reduce their risk by investing in bonds.

Asset allocation, correlation, and diversification are the main philosophies underlying hybrid funds. Asset allocation is the process of deciding how to distribute wealth among various asset classes; correlation is the co-movement of asset returns; and diversification is the presence of more than one asset in a portfolio.

Because the sources of risk and factors influencing returns for investment options within an asset class are similar, they tend to exhibit a high level of correlation in returns, whereas investment options across asset classes exhibit little correlation in returns.

Portfolio risk can be reduced by combining assets with low correlation. Hybrid mutual fund schemes diversify investments across multiple asset classes in order to maximize returns while minimizing risk. 

The allocation to each asset class is determined by the fund manager based on the fund’s investment objective and market conditions.

How does a Hybrid Fund work?

A hybrid fund aims to build a well-balanced portfolio that will provide its investors with regular income as well as long-term capital appreciation. The fund manager constructs a portfolio based on the scheme’s investment objective and allocates funds in varying proportions to equity and debt instruments. 

Furthermore, if market movements are favorable, the fund manager will buy or sell assets.

Who should invest in a Hybrid Mutual Fund?

Hybrid funds are riskier than debt funds but less risky than equity funds. They typically outperform debt funds in terms of returns and are preferred by many low-risk investors. Furthermore, new investors who are unsure about entering the equity markets prefer hybrid funds. This is because the debt component provides stability while they test the ‘waters’ of equity. Hybrid funds enable investors to get the most out of their equity investments while protecting themselves from market volatility.

What is the difference between Equity Funds, Debt Funds and Hybrid Funds? 

Equity FundsDebt Funds Hybrid Funds
Invests in company stocks.  Invests in debt securities and money market instruments.Invests in both equity and debt instruments. 
Returns are entirely dependent on market performance.Returns are more stable and are not affected by market performance.Returns are partly stable and partly dependent on market performance.
These funds are highly risky.These funds are less risky. These funds have a moderate level of risk.

Hybrid mutual fund types

  • Aggressive Hybrid Fund

Aggressive hybrid funds are open-ended hybrid schemes that invest primarily in equity and equity-related instruments, with the remainder invested in debt and money market instruments.

These funds have the potential to generate higher returns than conservative hybrid funds due to higher exposure to equity and equity-related instruments, but they are riskier.

  • Conservative Hybrid Fund

Conservative hybrid funds are open-ended hybrid schemes that invest 75% to 90% of their assets in fixed income generating securities such as Commercial Papers (CPs), Certificates of Deposit (CD), T-bills, corporate bonds, and other money market instruments.

The remainder is allocated to equity and equity-related instruments. These funds are less volatile than aggressive hybrid funds, making them appropriate for risk-averse investors.

  • Dynamic Asset Allocation Fund

As the name implies, a Dynamic asset allocation fund invests in both equity and debt based on current market conditions and an internal investment model. 

This fund is appropriate for investors seeking better risk-adjusted returns over the long term, regardless of market conditions.

  • Multi Asset Allocation Fund

Multi Asset Allocation Fund invests at least 10% of its portfolio in at least three asset classes and adjusts its allocation based on market conditions.

These funds typically invest in equity, debt, and gold-related instruments, as well as ETFs and other asset classes as prescribed by SEBI from time to time.

  • Arbitrage Fund

Arbitrage funds make money by profiting from price differences between two markets, typically the cash market and the futures market. These funds buy stocks in the cash market and sell them in the futures market.

Arbitrage funds invest at least 65% of their gross assets in equity and the rest in debt and money market instruments on a tactical basis.

  • Equity Savings Account

The equity savings fund invests in cash and derivative equity market equity, debt, and arbitrage opportunities. This fund seeks to generate income by investing in arbitrage opportunities with significant exposure to equity, with the goal of generating long-term wealth.

Why you should invest in Hybrid mutual funds?

  • Gain access to multiple asset classes:

One of the obvious benefits of hybrid mutual funds is that, rather than investing in multiple funds to meet the needs of different asset classes, an investor can access multiple asset classes in a single product.

  • Risk Management 

Active risk management is provided by hybrid mutual funds through portfolio diversification and asset allocation. They manage risk by combining asset classes that are not correlated, such as equity and debt.

  • Diversification:

They diversify the portfolio not only across asset classes, but also within asset classes. They invest in large cap, mid cap, or small cap stocks, as well as value or growth stocks, just like the overall equity allocation.

  • Adapts to a variety of risk profiles:

These funds can provide risk tolerance levels ranging from conservative to moderate to aggressive.

There are equity-oriented schemes for risk-takers and debt-oriented schemes for risk-averse investors, as well as the Dynamic Asset Allocation Fund for those who do not want to commit to a fixed asset allocation but want to move based on market views without making the calls themselves.

Arbitrage for investors seeking consistent returns in a volatile market.

  • Buying low and selling high:

The fund managers rebalance the portfolio to adjust the asset allocation within the permissible limit, resulting in the sale of one asset class when it is high and the purchase of another when it is low.

  • Rebalancing on its own:

The fund manager rebalances the portfolio as needed, and the investor is not required to do so. They save time and effort by tracking markets and managing asset allocation.

What is the taxation structure for Hybrid investments? 

The tax on gains in hybrid funds is as follows:

The Hybrid Fund’s equity component

This is taxed similarly to equity funds:

  • Long-term capital gains (LTCG) of more than Rs. 1 lakh are taxed at 10%, irrespective of indexation.
  • STCG (short-term capital gains) are taxed at 15%.

The Hybrid Fund’s debt component

This is taxed in the same way as any other pure debt fund. Capital gains are added to your income and taxed at the applicable tax rate.

Long-term capital gains from the debt component are taxed at a rate of 20% after indexation and 10% without it.

Key Take away 

  • Hybrid mutual funds are mutual funds that invest in more than one asset class, typically a mix of equity and debt assets, and sometimes gold.
  • Asset allocation and diversification are key philosophies underlying hybrid funds.
  • They intend to generate capital appreciation through equity allocation while reducing volatility through the portfolio’s debt component.
  • Risk tolerance levels in hybrid funds range from conservative to moderate to aggressive.
  • They are an excellent starting point for new investors in the equity market, and they can also be used to save for any specific medium-term goal.