“One should not put all their eggs in one basket” – this common saying serves as a valuable rule of thumb in the investment world. No single asset class has consistently been a winner for investors. Hence, for those looking for a middle ground to diversify their portfolios, hybrid funds are an ideal solution.
Investing can feel like walking a tightrope, where balancing risks and rewards is essential for achieving your financial goals. Based on your risk appetite, investments can be broadly classified into three types – equity (or high-risk) investments, debt (low-risk) investments, and hybrid mutual funds (a combination of equity and debt investment).
Hybrid Funds: A Mixed Bag Of Investments
Hybrid funds are versatile investment vehicles that allocate assets across asset classes, primarily providing exposure to equities (stocks) and debt funds (bonds and fixed-income securities). The goal is to harness the high-return potential of equities while mitigating volatility through the relative stability of debt instruments. This balanced approach gives them an edge compared to other funds that focus solely on single assets.
Further, hybrid mutual funds may also invest in other assets, including real estate, gold, IT, pharmaceuticals, and international equities. Fund managers actively dabble between different assets based on market conditions, economic trends, and the fund’s investment strategy. This dynamic mix offers potential for growth through market upswings or acts as a cushion, protecting investors from severe downturns.
Classifications of Hybrid Funds
Even under the broad umbrella of hybrid funds, investors can choose various sub-categories depending on the targeted asset allocation.
- Equity-Oriented Hybrid Funds: These funds allocate at least 65% of their total assets to equity and equity-related instruments. Also termed Aggressive Hybrid Funds, they are tailored for investors with a higher risk appetite seeking long-term growth.
- Debt-Oriented Hybrid Funds: These funds allocate at least 60% of their total assets to fixed-income securities, such as bonds, debentures, and government securities. Hence, they are more suitable for conservative investors looking for stable returns with limited market exposure. These open-ended mutual funds are also known as Conservative Hybrid Funds.
- Balanced Advantage Funds: Renowned as Dynamic Asset Allocation Funds, these actively shift the allocation between equity and debt based on market conditions. These funds are ideal for investors who want to automate their asset allocation, as they reduce exposure during high market valuations and increase it during lows.
- Arbitrage Funds: These funds buy stocks at a lower price in one market and sell them at a higher price in another market, generating debt-like low-risk returns through the price difference. Since there is simultaneous buying and selling, the fund does not carry the volatility of the equity asset class.
- Multi-Asset Allocation Fund: Such funds invest in at least three different asset classes with a minimum of 10% allocation to each, offering greater diversification.
Benefits of Hybrid Funds
Hybrid funds offer several key benefits, making them an attractive option for many investors.
- Diversified Asset Allocation: They diversify the portfolio across multiple asset classes and sub-classes.
- Active Risk Management: Hybrid mutual funds spread investments across multiple asset classes, wherein the equity component can offer capital appreciation, and the debt component acts as a buffer against market downturns.
- Tailored For Various Risk Profiles: There is no one-size-fits-all approach to hybrid funds. They offer varying risk tolerance levels, suitable for new investors, risk-takers, or goal-oriented investors.
- Automatic Rebalancing: Fund managers combine the high-return nature of equity and low-risk characteristics of debt to rebalance your portfolio whenever required.
Drawbacks Of Hybrid Funds
They are not without their disadvantages.
- Market Volatility: They are subject to market risks. Market fluctuations can lead to a decrease in the fund’s overall value.
- Interest Rate Sensitivity: Bonds under debt funds face interest rate risk. As bond prices move inversely to interest rates, the increased rates can depreciate the fund’s value.
- Lack Of Direct Control: Investors can analyze a hybrid fund’s portfolio, but they do not have direct or indirect control over the specific instruments. Therefore, they must have faith in their fund manager’s judgement and expertise.
Components To Consider Before Investing In Hybrid Funds
Mixed feelings about hybrid funds? Here’s what you should consider before zeroing in on one:
- Assess Risk: The risk in a hybrid fund depends on the proportion of equity in the portfolio. The higher the equity, the higher the risk. Make that risk-return evaluation before investing. For instance, a fund that earns most of its returns from interest on debt securities tends to be less risky than relying on stock price appreciation.
- Investment Timeline: Hybrid funds can cater to your medium to long-term goals. The longer the time horizon, the better chance of yielding stable, higher returns.
- Expense Ratio: Check the fund’s expense ratio, as higher costs can eat into your returns. Ensure you opt for cost-effective funds.
- Fund Manager’s Track Record: Analyze your fund manager’s investment approach and expertise in gauging the fund’s historical performance.
If you want the best of both worlds – growth potential with a safety net, hybrid mutual funds are your answer. These funds also serve as a reassuring entry point for investors who want to test the waters and slowly acclimatize to equity exposure. Think of it from a strategic standpoint – you can capitalize upon equity opportunities while mitigating market turbulence.
Frequently Asked Questions –
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How do you invest in a hybrid mutual fund?
You can either directly invest in a hybrid mutual fund through an Asset Management Company (AMC) or investment platforms like Stack’D. You will have to complete your KYC (Know Your Customer) process in both methods to initiate investing.
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What are the tax implications on hybrid funds?
Hybrid funds contain a combination of equity and debt instruments. Therefore, the tax implication hinges on which asset class dominates the fund.
Equity Taxation:
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- Long-term Capital Gains: Gains above Rs. 1.25 lakh are taxed at 12.5% without indexation
- Short-term Capital Gains: Taxed at 20% if units are sold within one year
Debt Taxation:
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- Long-term Capital Gains: Previously taxed at 20% with indexation, now considered short-term gains and are taxed at slab rates
- Short-term Capital Gains: Taxed as per an investor’s income tax slab
