3 min
05-August-2024
When it comes to investing in mutual funds, each asset class has its own opportunities and risks. Hybrid mutual funds have a balanced investment portfolio with investments in both equities and fixed-income securities. These funds capture the benefits of different asset classes to offer potentially higher returns with lower risks. Hybrid funds are best-suited for investors seeking diversification and a balanced approach to fulfil both short and long-term goals.
However, most investors are often confused about how to choose a hybrid fund, simply given the different subtypes available in the market. This article helps you understand how to choose a hybrid fund, what factors to consider, and what subtype may be best given your investment strategy.
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Whether you are a new investor or one with a moderate risk appetite, hybrid funds can help you capitalise on equity benefits while enjoying the safety of steady income from debt investments.
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However, most investors are often confused about how to choose a hybrid fund, simply given the different subtypes available in the market. This article helps you understand how to choose a hybrid fund, what factors to consider, and what subtype may be best given your investment strategy.
What exactly are hybrid funds?
Hybrid mutual funds are mutual fund schemes that invest in a combination of equity and debt securities. In other words, hybrid funds invest in both equity and debt markets, helping investors enjoy the best of both worlds. Part allocation in equity assets brings the potential of higher returns, while debt investments ensure portfolio stability during periods of market volatility. Diversification with investments in different asset classes ensures a balanced risk-to-reward ratio, making hybrid funds ideal for conservative investors seeking optimised returns without intense market risk.How to choose a hybrid mutual fund?
When investing in mutual funds, you should remember that there are different types of hybrid funds available in the market. As an investor, it is crucial for you to understand how to choose a hybrid mutual fund. Like all other investments, you must consider certain key factors before investing in a hybrid MF scheme. Here’s a list of factors to help you understand how to choose a hybrid mutual fund:1. Equity exposure
The equity-to-debt investment ratio varies across different hybrid funds. This means that the level of risk and rewards also varies from one scheme to the next. It is essential to consider the equity exposure of the fund since equity investments carry a higher risk quotient, but also the potential for higher returns. You need to carefully assess your risk appetite to pick schemes that best match your risk profile and return expectations.2. Age
If you are wondering, “How do I choose hybrid funds?” do not overlook the age factor. The general thumb rule states that your equity exposure should be equal to 100 minus your current age. Let’s say you are 30 years old. The right equity exposure for your age would be 100 - 30 = 70%. The underlying rationale is that equity markets tend to perform better in the long term. So, if you are a young investor, a higher equity exposure may be better than a conservative approach.3. Taxation
Another key aspect of how to choose hybrid mutual funds is taxation. As with all other MF investments, hybrid mutual fund investments also attract capital gains taxes. Unlike equity and debt funds that have specified taxation rates, hybrid funds are classified and taxed according to their equity exposure. If the equity exposure of the mutual fund scheme exceeds 65%, it will be taxed as an equity fund. Alternatively, if the equity exposure is below 65%, it will be taxed as a debt fund.4. Investment horizon
Investment horizon refers to the timeframe of your investment or when you will need the invested sum. If you’re investing for a long-term goal with a 5–10–year window, consider equity-oriented hybrid funds since equity investments tend to perform better in the long run. However, if you have a short-term investment horizon, say 3 years or so, consider debt-oriented funds that offer good short-term returns and volatility protection.Explore insightful articles to deepen your understanding of mutual funds:
When to pick hybrid funds and which one to pick?
For most investors, even after considering these factors, how to choose a hybrid mutual fund can still remain a baffling question. This is because of the sheer number of hybrid fund subtypes available in the market. So, if you are wondering, “How do I choose a hybrid fund?”, here’s a break-down of different types of hybrid funds and their suitability as per different risk profiles:1. Conservative hybrid funds
Conservative hybrid funds are designed with limited equity exposure to ensure better capital preservation. These funds primarily invest in debt securities and have the lowest equity allocation among all types of hybrid funds. The equity allocation of these mutual fund schemes can vary from anywhere between 10%-25%, while the debt allocation remains a sizable 75% to 90%. The objective of the fund remains to ensure stable income from debt instruments and possible spike in returns through limited equity exposure, making conservative hybrid funds perfect for risk-averse investors.2. Aggressive hybrid funds
Aggressive hybrid funds are the complete opposite of conservative funds. These hybrid funds focus primarily on equity-oriented securities, while a small part of the portfolio is dedicated to debt and money market instruments. Aggressive hybrid funds invest anywhere between 65%-80% of their total corpus into equity assets and the remaining in fixed-income securities. The higher equity exposure of these schemes means higher potential returns, but also higher risks. This makes them ideal for investors with a high risk tolerance and an investment horizon of over 5 years.3. Dynamic asset allocation fund / Balanced advantage funds
Dynamic asset allocation funds or balanced advantage funds are MF schemes that have the flexibility to change asset allocation in response to changing market conditions. The fund management team assesses and adapts its investment strategy, consistently looking for opportunities to maximise returns for investors. In short, dynamic asset allocation funds are best for investors who wish to capitalise on market trends but remain sceptical of volatility levels.4. Multi-asset allocation funds
Multi-asset allocation funds are funds that invest in at least 3 different asset classes, with a minimum exposure of 10% in each asset class. This includes equities and debt and another asset class, like gold or real estate. Multi-asset allocation funds allow investors to expose their portfolios to different asset classes with varying risk-reward ratios. This makes them perfect for investors seeking diversification benefits. Multi-asset funds are also well-suited for low-risk investors as they are designed to even out the risks associated with investment in just one asset class. Since these funds include assets that are negatively correlated (for example, stocks and gold), investors enjoy considerable protection even when one asset class underperforms.5. Arbitrage funds
Arbitrage funds are based on the idea of finding a price difference of a security in different markets and capitalising on the same. In other words, arbitrage funds capitalise on mispricing opportunities between two exchanges or two market segments, like the cash market and the futures market. The fund manager invests in equities only when he thinks there is a definite opportunity to earn returns. If no such opportunities for returns exist, investments are routed to short-term money market instruments and debt securities to generate stable income for the investors. Arbitrage funds are best suited for investors seeking to capitalise on a volatile market without shouldering high risks.6. Equity savings funds
Equity savings funds are hybrid mutual fund schemes that invest in a mixture of shares, bonds, and arbitrage options. At least 65% of their funds are dedicated to equity-linked investments, while a minimum of 10% is routed to debt instruments. While debt and arbitrage options add downside protection, the high equity exposure means potentially volatile returns. This equity-skewed allocation makes equity savings schemes well-suited for high risk investors.Conclusion
Hybrid funds offer instant diversification to investors. While hybrid funds are a mix of equity and debt investments, not all funds have the same allocation proportions. This means the equity exposure, and therefore, the risk, varies from one hybrid fund type to the next. Thus, investors deciding on how to choose hybrid mutual funds must consider their risk profile carefully before picking a fund. Factors like your risk appetite, age, investment horizon, and tax considerations determine how you choose a hybrid fund. Once you have determined your risk tolerance and investment objectives, you can invest in the right hybrid fund to ensure a balanced risk-to-reward ratio.Whether you are a new investor or one with a moderate risk appetite, hybrid funds can help you capitalise on equity benefits while enjoying the safety of steady income from debt investments.
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