Equity and debt are two distinct streams of investment options catering to two diverse classes of investors. However, what about investors seeking a middle ground, i.e., benefiting from equity and debt but avoiding their risks? Enter Hybrid Mutual Funds! These funds pick the best of both worlds offering investors a more stable yet faster-growing investment option. Curious to know more? Check out this blog to learn all you need to know about hybrid mutual funds to create a robust investment portfolio.
Hybrid mutual funds are investment funds that mix different types of assets, like stocks (equity), bonds (debt), and sometimes other options like gold or cash. The central idea behind hybrid mutual funds is to balance the growth and safety features in an investment option thereby catering to a larger audience. hybrid funds are popular because they allow investors to benefit from the potential high returns of stocks while reducing risk by including the stability of bonds. These funds are managed by professionals who decide how much to invest in each asset type, based on market conditions. The expense ratio of these funds is also lower as compared to equity funds making it cost-effective with usually more returns as compared to debt funds.
As mentioned above, hybrid funds combine the features of equity funds and debt mutual funds to eliminate their risks and provide maximum benefits for investors. The fund managers drive the investment approach in these funds based on the investment objective of the fund and market conditions. For example, if the stock market looks promising, the manager might allocate more money to stocks, aiming for higher returns. On the other hand, if the market is uncertain or risky, they may shift more money into bonds, which provide safer and steady returns. This ability to adjust the allocation helps hybrid funds perform well in different market conditions while reducing the overall risk.
Hybrid funds come in different varieties based on their mix of assets. For example, aggressive hybrid funds invest more in stocks, suitable for those seeking higher growth and willing to take some risk. Conservative hybrid funds, on the other hand, focus more on bonds, making them a better choice for cautious investors. The returns from these funds come from stock price appreciation, dividends, interest earned from bonds, or any gains from other investments in the portfolio.
SEBI and AMFI have classified hybrid mutual funds into several categories based on asset allocation. These types of hybrid mutual funds are explained hereunder.
Conservative hybrid funds invest a larger portion of the money (about 75-90%) in bonds or debt instruments, which are safer and provide stable returns. A smaller portion (10-25%) is invested in stocks to offer some growth potential. These funds are suitable for investors who prioritise safety and steady income but are willing to take a small amount of risk for slightly better returns than fixed deposits.
Balanced hybrid funds aim for an equal mix of equity (stocks) and debt (bonds), usually maintaining a 40-60% allocation in each. This balance helps to reduce the risks associated with stocks while still providing good growth opportunities. These funds are ideal for moderate-risk investors who want a mix of safety and long-term growth.
Aggressive hybrid funds invest more heavily in stocks (65-80%) and the rest in bonds (20-35%). They are designed for investors looking for higher growth and who can handle more risk. While these funds can offer better returns in the long term, they are also more volatile due to the larger exposure to the stock market.
These funds actively adjust the allocation between stocks and bonds based on market conditions. For example, they invest more in stocks during favourable market conditions and shift to bonds during uncertain times. This dynamic approach makes them flexible and suitable for investors seeking consistent returns with moderate risk.
Multi-asset funds invest in at least three different asset classes, such as stocks, bonds, gold or other commodities, with a minimum allocation of 10% in each. This diversification reduces risk by spreading investments across various assets. These funds are ideal for investors who want a highly diversified portfolio in a single fund.
Arbitrage funds take advantage of price differences between the cash market and derivatives market to generate returns. While the equity exposure is high, the risk is relatively low because the fund managers hedge their positions. These funds are suitable for risk-averse investors looking for short-term investments with returns similar to fixed deposits but with tax efficiency.
Equity savings funds combine investments in stocks, bonds, and arbitrage opportunities. The equity exposure is partially hedged to reduce risk, making it less volatile than aggressive hybrid funds. These funds are a good choice for investors seeking moderate returns with lower risks than pure equity funds.
The decision to invest in hybrid mutual funds is based on several factors and requires aligning the risk-return expectations to make informed investment decisions. The factors influencing investment in hybrid mutual funds include,
Risk appetite - Investors should evaluate their ability to handle market risks. Conservative funds are suitable for risk-averse individuals, while aggressive funds are better for those seeking higher returns and can tolerate volatility.
Investment Goals - A clear understanding of investment goals is like a first step in the right direction to invest in a fund. Defining financial objectives, such as wealth creation, income generation, or capital preservation, helps in selecting a fund that aligns with these goals.
Fund Type - Hybrid mutual funds offer a variety of investment options depending on the risk exposure and the investment goals of the investor. This can help investors in choosing the appropriate type of hybrid fund, whether growth-focused (aggressive) or stability-oriented (conservative or balanced), based on the investor’s needs.
Expense Ratio - The expense ratio of the fund has a direct impact on the net returns received by the investor. Hence, investors should choose a fund that is lower among the available options leading to higher net returns.
Historical performance - While the historical performance of a fund cannot guarantee returns in the long run, it certainly helps in choosing a fund that has consistently performed well in the past.
Investment Horizon - The investment duration is another factor that plays a key role in the decision-making process. Short-term goals may align with arbitrage funds, while long-term objectives might benefit from aggressive or balanced hybrid funds thus enabling investors to make informed decisions.
Fund Manager Expertise - The fund manager is similar to a person in the driving seat or the force behind making or breaking a fund. Hence, it is crucial to understand and evaluate their track record, qualifications, experience and their ability to navigate the fund during market fluctuations.
Exit Load and Lock-in Periods - Investors should review any exit loads (charges for early withdrawal) or lock-in periods that might limit liquidity.
Returns from hybrid mutual funds are in the form of dividends and interest from the fund as well as capital gains at the time of sale of the units. While dividends and interest from the fund are taxed in the hands of the investors at applicable slab rates, capital gains tax depends on the nature of the funds, i.e., on their equity exposure and the holding period of the investment. The Union Budget 2024 introduced significant changes to the tax structure for mutual funds, effective from July 23, 2024, that have impacted hybrid mutual funds too.
The details of taxation of hybrid mutual funds are explained hereunder.
Funds with more than 65% allocation in equities are treated as equity mutual funds. Short-term capital gains (holding period up to 12 months) are taxed at 20%, increased from the previous 15%. Long-term capital gains (holding period over 12 months) are taxed at 12.5%, up from 10%. Additionally, the exemption limit for long-term capital gains has been increased from Rs. 1,00,000 to Rs. 1,25,000 per year.
Funds with more than 65% allocation in debt instruments are considered debt mutual funds. For investments made after April 1, 2023, capital gains are always treated as short-term and taxed according to the investor's income tax slab rates. For investments made before April 1, 2023, the holding period for long-term capital gains has been reduced from 36 months to 24 months, with long-term gains taxed at 12.5%.
The taxation of hybrid mutual funds is tabled hereunder.
Hybrid mutual funds are ideal for investors seeking a balance between growth and stability in their portfolios. These funds suit individuals with varying risk appetites, as they offer a mix of equity (for growth) and debt (for safety). Conservative investors who want steady returns with minimal risk can opt for conservative hybrid funds, while aggressive investors looking for higher returns over the long term can choose funds with a larger equity allocation.
Hybrid funds are also a good choice for first-time investors who want to enter the stock market but prefer a less volatile option. Additionally, these funds are suitable for those with medium to long-term financial goals, such as saving for a child’s education, purchasing a house, or planning for retirement. By offering diversification in a single fund, hybrid funds simplify the investment process and reduce the need for constant monitoring, making them a convenient option for Indian investors across different life stages.
Hybrid mutual funds offer a balanced approach to investing in mutual funds but also come with a set of risks. Hence, it is important for investors to understand the risks and benefits of investing in hybrid mutual funds before taking the dive. Here is a brief insight into the same.
Hybrid mutual funds are a perfect solution to balance investment in equity and debt instruments. They combine the growth potential of equities with the stability of debt, making them suitable for a wide range of investors. However, the key to investing in hybrid mutual funds, like any other investment option is to understand the nuances in detail and make an informed investment decision.
We hope this blog helped you in understanding hybrid mutual funds in detail. Let us know if you have any queries or need more information and we will take it up.
Till then Happy Reading!
Read More: Pros and Cons of Mutual Fund Investing
Marisha Bhatt is a financial content writer @TrueData.
She writes with the sole aim of simplifying complex financial concepts and jargon while attempting to clarify technical and fundamental analysis concepts of the stock markets. The ultimate goal is to spread vital knowledge and benefit the maximum audience. Her Chartered Accountant background acts as the knowledge base to help clarify crucial concepts and create a sound investment portfolio.
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