What are Hybrid Funds – All You Need To Know

Hybrid Funds, as the term suggests, invest in a mix of various asset classes like equities, debt, gold, and even real estate. Usually, most hybrid funds experiment between equities and debt instruments to create a diverse portfolio. They allocate assets in a blend of equity and debt so that they can tap the benefits of both. The equities can generate high returns but are also highly volatile whereas the debt can give stable returns at low risk. This evenly distributes the risk factor where debt securities can counterbalance the negative impact of equity markets. Otherwise, the equity can generate good returns when times are favorable.

Hybrid funds have the potential to generate better returns than debt funds and are also relatively safer than equity funds. However, various types of hybrid funds have varying combinations of equity and debt securities where it allocates more funds to a particular asset category. Let’s understand in detail what hybrid funds are, their types, and if they are the same as balanced funds.

Hybrid Funds – Definition and Features

Equity or debt funds invest more than 65% of the fund corpus in their respective asset categories, that is, equities/stocks and debt securities. In the case of Hybrid Funds, the asset allocation is such that the equity and debt instruments are in balanced proportion. It may invest 40-60% of the fund money in one asset class and the rest in the other. Hybrid funds can be equity-oriented if they invest more in equities, or debt-oriented if they allocate more funds to debt instruments. Some funds can dynamically change the asset allocation ratio depending on the market conditions.

Features of Hybrid Funds

Hybrid funds are good for investors who want limited exposure to equities as well as debt. Some of the basic features of hybrid funds are:

  • It has a diverse portfolio containing both equities and debt as well as other assets in its investment strategies. You invest in multiple asset categories through one fund
  • Hybrid funds have a balanced portfolio where they can make the best of both asset classes. It endeavors to give higher returns with lesser risks and also to help you achieve both your short-term and long-term financial goals. Equity components help in generating wealth in the long run whereas the debt securities cushion against market fluctuations
  • Good for investors who wish to have stable returns or want a better alternative to both equity and debt funds. As hybrid funds invest in multiple assets, there is little correlation between their risk factors, and that reduces the portfolio risk
  • Various types of hybrid funds have different types of equity-debt combinations. They are designed to meet the financial needs and investment goals of different kinds of investors. It also caters to the risk tolerance of large-scale investors, from conservative and moderate to aggressive. For instance, it may invest more in stocks that are suited for investors with higher risk tolerance. While conservative investors will go for hybrid funds that invest more in debt
  • The hybrid fund investment is apt for investors who can hold the units for at least 3 to 5 years. They say the longer the time horizon, the better. Hybrid funds can give fruitful results through wealth creation in the long run and income generation in the short-term

Types of Hybrid Funds

Hybrid funds can be categorized into various types based on their asset allocation and investment strategy. The different types of hybrid funds are listed below:

  1. Aggressive/Equity-Oriented Hybrid Fund

Hybrid funds that invest more in equities than debt are equity-oriented funds. They are called aggressive funds as they are riskier with higher equity components but can also generate high returns. They are suitable for aggressive investors where 60-65% of the investible corpus is used in equities and the remaining in debt.

  1. Conservative/Debt-Oriented Hybrid Fund

This fund allocates its resources in just the opposite manner as that of equity funds. It allocates about 60% to debt and about 40% to equities, making it apt for conservative investors. Debt-oriented funds cater to those investors that seek stable returns with low risk. Some funds also invest a little share in liquid funds, cash, or cash equivalents so as to influence the liquidity of the portfolio positively.

  1. Balanced Funds

Balanced funds are a type of hybrid funds that allocate funds to equity and debt classes on an almost equivalent proportion. They invest equal amounts in stocks and fixed income securities making it a healthy capital appreciation avenue with lower risks.

  1. Balanced Advantage/Dynamic Asset Allocation Funds

Balanced Advantage Funds are often confused with balanced funds. While balanced funds invest almost equally in a balanced ratio, balanced advantage funds try to balance the fund allocation to withdraw optimum advantage. When markets are favoring, fund managers allocate more funds to equities and purchase more stocks. They shift to debt securities when the markets are fluctuating. This way, the funds are able to derive maximum profits in each circumstance and returns along with the stability.

The fund managers actively manage the funds and keep an eye on the prevailing market conditions to increase or decrease the weightage to a certain asset category. They dynamically change the exposure to the equity or the debt and hence, are called dynamic asset allocation funds.

  1. Multi-Asset Allocation Funds

The hybrid funds that invest in more than 2 asset categories with at least 10% of the fund in each are multi-asset allocation funds. They allocate funds in at least three asset classes like equity, debt, and any third one like gold, real estate, etc. Lesser risks than many hybrid funds as the corpus is allocated to multiple asset classes but also gives lower returns than equity-oriented ones.

  1. Arbitrage Funds

Arbitrage funds capitalize on inefficient markets by simultaneously buying stocks and bonds in one market and selling it to the other. The fund managers use this strategy to make the most benefit out of the difference in prices in different markets. They usually buy in the cash market and sell in the future market to draw the capital. Fund managers have a tactical approach in exposing the fund corpus to both assets.

  1. Monthly Income Plans (MIPs)

A monthly income plan (MIP) invests primarily in debt rather than in equities but gives better returns than pure debt funds due to the presence of equity elements. Funds may offer a growth plan where the dividends are added and reinvested. But you can also go for a dividend plan to get the profits as regular income from investment. You can payouts on a monthly, quarterly, bi-yearly, or yearly basis.

Taxation:

The taxation of hybrid funds depends on their composition and the components through which the capital gains are achieved. Capital gains through equities are taxed as per the taxation norms of equity funds. Capital gains through debt components are subject to taxation as per the rules of debt funds. It further matters if it is long-term capital gain (LTCG) or short-term capital gain (STCG). STCG through equity is taxed at 155 and LTCG at 10% without indexation benefits if it exceeds Rs. 1 Lakh.

Debt component, LTCG is taxed at 20% after indexation and 10 % without the benefits of indexation. STCG through debt is added to the income and tax is deducted as per the income slab that one falls into. Arbitrage funds are often considered safe as debt funds but have the tax calculation for long-term gains like the equity funds.

Wrapping it up:

Hybrid Funds invest in more than one type of asset, thus creating a balanced and diverse portfolio. The balanced ratio of equity and debt help in generating high returns and beating the market volatility at the same time. This way, it is suitable for investors who want growing returns than that of a debt fund with higher security than equity funds. Among hybrid funds, a large variety of funds based on its asset allocation ratio suits a multi-range of investors.

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