Hybrid Mutual Funds

Mutual funds that invest in both Debt and Equity are known as Hybrid Mutual Funds. Earlier known as Balanced Funds, they achieve the perfect amalgamation of decent returns and maximum diversification. These funds are suitable for investors expecting a good return at moderate risk. An investor may make an informed choice of the Hybrid Fund depending on their risk preferences and investment objective. This article talks about Hybrid Mutual Funds and its various aspects.

Objective

The primary aim of Hybrid funds is to attain wealth appreciation in the long run. Along with this, Hybrid funds function to generate income in the short-run with the help of a balanced portfolio. To start with one, a fund manager would allocate an interested individual's money in varying proportions in debt and equity based on the investment objective of this fund. Hybrid funds may be debt oriented or equity oriented.

Functioning

The fund manager would invest about 65% or more of the fund's assets in Equity, Debt and Money Market Instruments. A fund can be termed as oriented according to the percentage of investment the manager has allocated the funds into. If 65% or more of the fund's assets are invested in Equity, while the rest is invested in Debt and Money Market Instruments (MMF), it can be called an Equity-oriented fund. On the other hand, if 60% of assets are allocated in Debt, while the rest are in Equity, then it can be called a Debt-oriented fund. Some percentage of the funds would also be invested in cash and its equivalents for the sake of liquidity. The equity component of the Hybrid fund would comprise of equity shares of entities across industries such as finance, real estate, healthcare, automobile and so on. Whereas, the debt component of the Hybrid fund would constitute investments in fixed-income havens such as government securities, bonds, debentures, treasury bills and more. Depending on the marking movements, the fund manager may choose to buy or sell securities to have an upper-hand of the situation.

Benefits of Hybrid Funds

The following are the benefits of investing in Hybrid funds.

These funds generate higher returns as they comprise of different asset classes.
Investors have the option to switch from one combination of assets to another that may offer more opportunities growth-wise. Changes can be made with the fluctuations occurring due to market conditions.
These investments may be managed by the investor itself with ease. Although, an expert fund manager may come into use to make changes to the portfolio.
These investments may be managed by the investor itself with ease. Although, an expert fund manager may come into use to make changes to the portfolio.

Investors of Hybrid Funds

Hybrid funds are considered to be safer to bet on than pure equity funds. It is a known factor that these funds have higher returns than pure debt funds. Hence, making them the go-to funds for conservative investors. Hybrid funds are also popular among budding investors who are keen on taking a step into equity markets. Being the ideal blend of debt and equity, the equity component in these funds helps to ride the equity wave. Similarly, the debt component of these funds offers the investor a safety net to fall on in case of extreme market turbulence. This way, an investor may receive stable returns without risk of total burnout, which is possible in the case of pure equity funds. The dynamic fund allocation feature of hybrid funds have become an excellent way for the less conservative category investors to make the most out of market fluctuations.

Types of Hybrid Funds

Hybrid funds may be categorised according to the allocation of their assets. Some kinds of hybrid funds have a higher allocation concerning equity and less in debt, while others may have it the other way around. Below are the types of Hybrid funds and their essentials.

Balanced Funds

Balanced funds are considered the most popular kind of hybrid funds. When it comes to asset allocation, balanced funds invest 65% or more of their portfolio in equity and equity-oriented instruments. This qualifies them to be equity funds for the sole purpose of taxation. This means that profits of or above INR 1 Lakh from a Balanced fund held for one year is taxable at a 10% rate. The remaining of the assets would be invested in debt securities, and a small portion might also be kept in cash. Balanced funds are a perfect investment option for conservative investors who look forward to profits from the return-earning capacity of equities minus the risks. Equity-related risks could be mitigated with the help of fixed income exposure of Balance funds.

Monthly Income Plans (MIP)

Monthly Income Plans (MIP) are hybrid funds that allocate or invest most of their funds in debt instruments. These hybrid funds would typically have an exposure of 15% - 20% to equities. This helps them to generate high returns instead of regular debt funds. MIPs offer income to the investor regularly in the form of dividends. An interested investor may choose the frequency of the dividends, which could be monthly, quarterly, half-yearly or annually. These are the options accessible in the dividend option. Moreover, Monthly Income Plans come with the option to grow that does not pay out a dividend. These plans let the investments frow in the fund's corpus. There, MIPs should not be considered as a simple monthly income investment as the name may be misleading to new investors. MIPs must be regarded as hybrid funds that invest in debt most of the time and a small share of equities.

Arbitrage Funds

Arbitrage funds are the kind of funds that try to take advantage of the mispricing in the price of a particular stock between the futures market and derivatives market. These funds are mainly equity-oriented mutual funds. The fund manager in charge of the investments keeps an eye out to opportunities to maximise returns by purchasing stocks at a low price in a specific market and selling it at a higher value in another market. Although, arbitrage opportunities would not necessarily be available at ease. The funds may remain to be invested in debt instruments or cash in the absence of arbitrage opportunities. This is the reason why they are considered to be hybrid funds. Arbitrage funds are comparatively safer by their design. They are considered to be equity funds when it comes to taxability, and long-term returns generated from these funds are taxable under the law.

Investor's Checklist

There are some fund houses that offer hybrid funds specifically designed for children's education or retirement. These kinds of hybrid funds come with a preset goal-orientation. An investor has to completely understand how the assets are allocated before committing to any investment. An investor has to consider the following before any investment.

Risks

It is considered unwise for investors to assume that hybrid funds are entirely risk-free. This comes with the knowledge that any instrument would have some related risks if it is invested in equity markets. Even though it may be less risky when compared to pure equity funds, an investor needs to be aware and cautious by rebalancing their portfolio frequently.

Returns

Guaranteed returns are not offered by Hybrid funds. The Net Asset Value (NAV) of these kinds of funds would be affected by the performance of underlying securities and hence, may vary depending on market movements. It should also be kept in mind that Hybrid funds may not declare dividends during market downturns.

Costs

In order to manage an investor's portfolio, Hybrid funds would charge a fee which is called an Expense Ratio. An interested investor has to ensure that the funds have a low Expense Ratio than other competing funds before deciding to invest. This would roughly translate into higher returns for an investor to take home.

Investment Term

An investment term or horizon of 5 years is considered ideal for Hybrid Funds. If an investor aims to generate a risk-free rate of return, then they should opt for Arbitrage funds as it bets on a securities' price differentials in different markets.

Financial Objectives

Hybrid funds may be used for any intermediate financial objectives or goals such as for purchasing a car or for funding their children's higher education. It is wise for retirees to invest in balanced funds and opt for a dividend option to initiate their post-retirement income.

Tax on Profits

The component of equity in a hybrid fund is considered to be similar to equity funds when it comes to taxes. Equity components that generate a long-term capital gain of more than INR 1 Lakh are levied with tax at a rate of 10%. Whereas, the tax rate for short-term capital gains is 15% on equity components. On the other hand, a hybrid funds' debt component is levied with tax similar to debt funds. Short-term capital gains from a debt component are added to an investor's income and a tax, according to the individual's income slab, would be applicable. However, a tax rate of 20% after indexation and 10% without the benefit of indexation is applicable for long-term capital gains from debt components.