Hybrid mutual funds are investment vehicles that diversify across multiple asset classes, typically blending equity and debt. These funds may also include other assets like real estate or commodities to create a balanced risk-return profile. A common example is a balanced fund, which allocates around 60% to stocks and 40% to bonds.
In this article, we’ll explore hybrid mutual funds in detail, covering their definition, features, and types. Additionally, it will explain how these funds work, the tax implications, and which investors are best suited for them, focusing on equity-oriented schemes.
What are hybrid mutual funds?
Hybrid mutual funds are a type of mutual fund that invest in a mix of different asset classes, such as equity, debt, gold, etc. The proportion of each asset class may vary depending on the fund’s objective, risk profile, and market conditions. Hybrid mutual funds aim to provide a balance of growth and stability to the investors by diversifying their portfolio across various assets.
How a hybrid mutual fund works
Hybrid mutual funds blend the growth potential of stocks with the stability of debt instruments. Let us explore how these versatile funds function to achieve balanced returns:
- A hybrid mutual fund collects money from the investors and allocates it to different asset classes according to its investment strategy.
- The fund manager monitors the performance of each asset class and adjusts the allocation as per the market conditions and the fund’s objective.
- The fund generates returns from the capital appreciation and/or income distribution of the underlying assets.
- The investors can redeem their units at the prevailing net asset value (NAV) of the fund.
Features of Hybrid Funds
Asset Allocation
Hybrid funds are characterised by their diversified asset allocation, combining equities, bonds, and sometimes alternative assets like gold or real estate. This blend aims to balance risk and reward, offering the potential for growth from equities and stability from fixed-income securities. The proportion of each asset class varies depending on the fund’s objective, ranging from conservative to aggressive.
Risk Management
By spreading investments across multiple asset classes, hybrid funds inherently reduce risk through diversification. The equity component can capitalise on market upswings, while the fixed-income portion provides a buffer during downturns. This balanced approach helps to smooth out the volatility typically associated with pure equity funds, making hybrid funds suitable for investors with moderate risk tolerance.
Income Generation
Hybrid funds can generate income through interest from bonds and dividends from equities. Some hybrid funds are tailored to focus more on regular income, ideal for investors seeking a steady cash flow. These funds might invest more heavily in high-yield bonds or dividend-paying stocks, balancing the need for income with the potential for capital appreciation.
Types of hybrid mutual funds
There are different types of hybrid mutual funds based on the proportion of equity and debt in their portfolio. Some of the common types are:
- Aggressive hybrid fund: This type of fund invests predominantly in equity (65-80%) and the rest in debt. It is suitable for investors who have a high risk appetite and a long-term investment horizon. It aims to provide high growth potential with moderate stability. Read more about, What are aggressive hybrid mutual funds.
- Conservative hybrid fund: This type of fund invests predominantly in debt (75-90%) and the rest in equity. It is suitable for investors who have a low risk appetite and a short to medium-term investment horizon. It aims to provide regular income with low volatility. Read more about, What are conservative hybrid mutual funds.
- Balanced hybrid fund: This type of fund invests equally in equity and debt (40-60% each). It is suitable for investors who have a moderate risk appetite and a medium to long-term investment horizon. It aims to provide a balance of growth and stability.
- Hybrid equity fund: This type of fund invests mainly in equity (65-80%) and the rest in other asset classes, such as gold, real estate, etc. It is suitable for investors who have a high risk appetite and a long-term investment horizon. It aims to provide high growth potential with diversification benefits.
- Hybrid debt fund: This type of fund invests mainly in debt (65-80%) and the rest in other asset classes, such as equity, gold, etc. It is suitable for investors who have a low risk appetite and a short to medium-term investment horizon. It aims to provide regular income with the benefits of diversified investments.
- Arbitrage fund: These funds exploit price differences between similar securities on different markets. They quickly buy low and sell high, aiming for steady, low-risk returns with minimal market exposure. Read more about, What are arbitrage funds.
- Multi asset allocation fund: This type of fund goes beyond stocks and bonds. It combines at least three asset classes, often including equity, debt, and real estate or gold. The fund manager actively allocates your investment across these classes based on market conditions, aiming for diversification and balanced risk-adjusted returns. Read more about, What are multi asset allocation mutual funds.
Benefits of hybrid mutual funds
Hybrid mutual funds offer a compelling mix of growth and stability. Let us delve into the key advantages these funds provide for investors seeking a well-rounded approach:
- Diversification: Hybrid Mutual Funds offer diversification by investing in a mix of equity and debt instruments, spreading risk across different asset classes.
- Risk management: The combination of equity and debt helps manage risk, providing stability during market fluctuations while retaining the potential for capital appreciation.
- Optimal asset allocation: Professional fund managers dynamically adjust the allocation between equity and debt based on market conditions, ensuring optimal asset allocation.
- Stable returns: Hybrid funds aim for stable returns by balancing the growth potential of equities with income generation from debt instruments.
- Convenience and simplification: Hybrid funds simplify investing by offering a single option that combines different asset classes, reducing the need for investors to manage separate portfolios.
Taxation rules of hybrid mutual funds
Understanding how taxes apply to your hybrid mutual fund investments is crucial for making informed financial decisions. Here's a breakdown of the key points:
Taxation depends on investment type:
Hybrid funds hold a combination of equity and debt instruments, and the tax treatment hinges on which asset class dominates the fund.
Equity Taxation:
- Long-term capital gains (held over 1 year): Up to Rs. 1 lakh exempt from tax. Gains exceeding Rs. 1 lakh attract a 10% tax without indexation benefit (a method to adjust for inflation).
- Short-term capital gains (within 1 year): Taxed at a flat 15%.
Debt Taxation:
- Long-term capital gains (held over 3 years): Taxed at 20% with indexation benefit.
- Short-term capital gains (within 3 years): Added to your income and taxed according to your income tax slab.
Dividend Distribution Tax (DDT):
Not applicable to dividends received from hybrid funds.
How should you invest in a hybrid mutual fund?
Diversifying your portfolio with hybrid mutual funds can be a smart way to balance growth potential with income generation. But how do you actually invest in them?
There are two main options:
- Direct investment with the AMC (Asset Management Company): Each AMC manages its own set of mutual funds, including hybrids. You can visit the website of your chosen AMC and explore their offerings. They will likely require you to register and complete the mutual fund KYC (Know Your Customer) process, which verifies your identity and investment suitability. Once KYC is complete, you can initiate investments directly with the AMC.
- Investing through an investment platform: Online platforms like the Bajaj Finserv Platform offer a user-friendly way to invest in hybrid funds from various AMCs. Here's how to invest:
- Sign up: Create an account on the Bajaj Finserv website or mobile app.
- KYC completion: Similar to the AMC method, KYC verification is mandatory. Submit your documents through the platform for a smooth online experience.
- Fund selection: Bajaj Finserv platform offers a curated selection of hybrid funds based on risk tolerance and investment goals. Browse their options to find a fund that aligns with your needs.
- Investment initiation: Once you have chosen a fund, simply invest your desired amount.
Remember, regardless of the chosen method, the actual investment happens with the AMC. The platform you choose simply simplifies the process and provides additional features like investment tracking and portfolio management tools.
Why should you invest in a hybrid mutual fund?
Hybrid funds present a compelling option for investors looking to diversify their portfolios. Positioned between the risk spectrum of debt and equity funds, they offer a balance that appeals to those seeking moderate risk with potentially higher returns compared to pure debt investments.
For novice investors cautious about entering the volatile equity markets, hybrid funds serve as a reassuring entry point. The presence of a debt component provides stability, easing apprehensions as investors gradually acclimate to equity exposure.
Moreover, hybrid funds offer a strategic advantage by enabling investors to capitalise on equity opportunities while mitigating the impact of market turbulence. This unique feature enhances their appeal, particularly to risk-averse individuals seeking a blend of growth potential and stability in their investments.
Ideal investors for hybrid mutual funds
Hybrid mutual funds are ideal for investors who want to diversify their portfolio across different asset classes and balance their risk and return. They are also suitable for investors who want to benefit from the changing market conditions and invest for a medium to long-term horizon.
However, not all hybrid funds are the same and investors should choose a fund that matches their specific needs and goals.
For instance:
- Investors who want to save tax and have a high risk tolerance can opt for an aggressive hybrid fund that qualifies for equity-linked savings scheme (ELSS).
- Investors who want to generate regular income and have a low risk tolerance can opt for a conservative hybrid fund that invests mainly in debt instruments.
- Investors who want to have a balanced exposure to both equity and debt can opt for a balanced hybrid fund that invests equally in both asset classes.
- Investors who want to diversify their portfolio beyond equity and debt can opt for a hybrid equity fund or a hybrid debt fund that invests in other asset classes, such as gold, real estate, etc.
Disadvantages of hybrid mutual funds
- Market volatility: Due to exposure in the equity market, hybrid funds are susceptible to market risks. Fluctuations in stock prices can lead to a decrease in the fund's overall value.
- Credit default risk: Opting for debt instruments with low credit ratings may expose hybrid funds to credit risk. High chances of default by companies on interest and principal payments can significantly impact the fund's value.
- Interest rate sensitivity: Hybrid funds, holding bonds, face interest rate risk. As bond prices move inversely to interest rates, an increase in rates can lead to a decline in the fund's value.
- Reliance on past performance: Relying solely on past performance when selecting a hybrid fund may be misleading. It is essential to evaluate the fund's portfolio, the balance between equity and debt, and macroeconomic conditions for a more accurate assessment.
- Lack of direct control: While investors can analyse a hybrid fund's portfolio, they have no direct or indirect control over specific equity or debt instruments. Trust in the fund manager's judgment becomes crucial, necessitating reliance on their decisions for fund investment.
List of some hybrid mutual funds in India 2024
- HDFC Balanced Advantage Fund
- JM Aggressive Hybrid Fund
- ICICI Prudential Equity & Debt Fund
- ICICI Prudential Multi Asset Fund
- Bank of India Mid & Small Cap Equity & Debt Fund
- ICICI Prudential Retirement Fund - Hybrid Aggressive Plan
- Quant Absolute Fund
- Kotak Multi Asset Allocator FoF - Dynamic
How to pick the best hybrid mutual fund?
Selecting the best hybrid mutual fund requires evaluating several key factors that align with your financial goals. First, assess your risk tolerance. Hybrid funds come in various types, with some leaning more towards equities (high-risk) and others favouring debt (low-risk). Understanding your comfort level with risk will help you choose a fund with the right equity-debt mix. Also, consider your investment horizon; equity-oriented hybrid funds are generally better suited for long-term goals, while debt-oriented funds may be more appropriate for short-term needs.
Secondly, evaluate the fund’s performance and management. Look at the fund's historical returns, though past performance isn't a guarantee of future results. Research the fund manager’s expertise and strategy, as this can significantly impact returns. Additionally, compare expense ratios to ensure you aren’t paying more in fees than necessary.
- Assess risk: Understand your risk appetite and choose a fund with the right equity-debt allocation.
- Check performance: Review historical returns and fund manager expertise.
- Analyse costs: Compare expense ratios to ensure the fund is cost-effective.
Factors to consider before investing in hybrid mutual funds
Before investing in hybrid mutual funds, investors should consider the following factors:
- Risk-return trade-off: Hybrid mutual funds offer a trade-off between risk and return. The higher the equity exposure, the higher the potential return and the higher the risk. The lower the equity exposure, the lower the potential return and the lower the risk. Investors should choose a fund that matches their risk appetite and return expectation.
- Fund performance: Investors should compare the performance of different hybrid funds over different time periods and market cycles. They should look at the fund’s consistency, volatility, and benchmark comparison. They should also check the fund’s expense ratio, exit load, and tax implications.
- Fund objective: Investors should understand the fund’s objective and investment strategy. They should check the fund’s asset allocation, sector allocation, and portfolio composition. They should also check the fund’s investment style, whether it is value-oriented, growth-oriented, or blend-oriented.
- Fund manager: Investors should evaluate the fund manager’s experience, expertise, and track record. They should check the fund manager’s investment philosophy, process, and approach. They should also check the fund manager’s tenure, team size, and turnover.
Conclusion
Hybrid mutual funds are a versatile option for investors who want to diversify their portfolio and balance their risk and return. They offer different types of funds to suit different needs and goals. However, investors should do their own research and understand the fund’s objective, performance, and tax implications before investing.
