Hybrid Funds

Investors in mutual funds can be divided into three types. First are the individuals willing to risk and invest in equity funds. Second, those who want to be secure by investing in debt funds, which provide some returns while keeping their money safe, and third, those who want the best of both worlds by investing in hybrid funds.

Most investment advisors advise clients to develop an investing strategy based on their financial objectives, risk tolerance, and time horizon. However, because everyone's needs and goals are different, it's difficult to categorize an investor as purely high-risk or low-risk. Hybrid Mutual Funds can help in this situation. Here, we'll look into Hybrid Funds and discuss some key elements to be aware of before investing in them.

What Are Hybrid Funds?

Hybrid funds invest in debt and equity funds to diversify and reduce concentration risk. A proper mix of the two provides better returns than a traditional debt fund while avoiding the risks of equity funds. Your risk tolerance and investing objective determine the type of hybrid fund you choose. Therefore, as the name suggests, hybrid means a combination of equity and debt assets that achieve the scheme's investment goal. Each hybrid fund has a unique mix of equity and debt to appeal to various investors.

How Does Hybrid Fund Work?

The fund manager aims to create a balanced portfolio by allocating funds to generate long-term capital appreciation along with short-term income. The fund manager constructs a portfolio based on the scheme's investment goal, allocating money between equities and debt instruments in varying quantities. In addition, if market conditions are favorable, the fund manager buys or sells assets.

Who Should Invest In Hybrid Funds?

These funds are popular among conservative investors since they offer more significant returns than actual debt funds. It is a great alternative for new investors who are unsure about the equity stock market. The inclusion of equity funds in the portfolio increases the likelihood of better returns. At the same time, the fund's debt component protects it from excessive market changes.

They are regarded to be riskier than debt funds but safer than equity funds. As a result, they tend to give greater returns than debt funds and are recommended by many low-risk investors. As a result, you get consistent returns rather than the absolute burnout that may occur with only equities funds. In addition, for less cautious investors, some hybrid funds' dynamic asset allocation feature can be an excellent way to get the most out of market volatility.

Types Of Hybrid Funds

There are a variety of funds available, each with a different asset allocation. Investors should select a hybrid fund that matches their risk tolerance, time horizon, and investment purpose.

Aggressive Hybrid Funds

Aggressive hybrid funds are open-ended hybrid funds that invest primarily in stock and equity-related instruments, remaining in debt and money market instruments. They invest between 65 % of their assets in equities and equity-related instruments. Because of their increased exposure to equity and equity-related securities, these funds have the potential to deliver more significant returns than conservative hybrid funds, but they are also riskier.

Conservative Hybrid Funds

A debt-oriented fund is one in which the fund manager devotes more than 65 percent of its assets to debt securities. Government securities, bonds, treasury bills, and other fixed-income instruments are included in the debt component of the fund. For liquidity reasons, a portion of the fund would be placed in cash and cash equivalents.

Balanced Funds

Balanced funds or dynamic asset allocation funds invest in equities and debt based on current market circumstances and an internal investing strategy. This product is appropriate for investors seeking higher risk-adjusted returns over the long run, regardless of market circumstances.

These funds invest at least 65 percent of their total assets in equities and equity-related instruments, with the remaining assets split between debt securities and cash. They are treated as equity funds for tax purposes, and long-term capital gains of up to Rs. 1 lakh are tax-free. It is a suitable alternative for stock investors since the fixed income component helps minimize the volatility of equity investments.

Monthly Income Plans

These are hybrid funds that primarily invest in debt securities. A monthly income plan (MIP) would typically include a 15-20% equity exposure. MIPs provide investors with a monthly income in the form of dividends. Dividends might be paid monthly, quarterly, half-yearly, or annually, depending on the investor's preference.

Arbitrage Funds

An arbitrage fund manager attempts to maximize profits by purchasing a stock at a lower price in one market and selling it in a different market for a greater price. Arbitrage chances, on the other hand, are not always readily available.

During these situations, the fund generally invests in debt securities and cash. As a result, arbitrage funds are seen as equally secure as debt funds. On the other hand, long-term capital gains are taxed similarly to equity funds.

Factors To Consider Before Investing In Hybrid Funds

There are some essential factors to consider when investing in these funds.

Risk: Any investments carry a certain amount of risk along with it. It is less risky than equity instruments, and therefore you must regularly exercise vigilance and rebalance your portfolio.

Return: Returns on hybrid funds are not guaranteed. The Net Asset Value (NAV) of these funds is influenced by the performance of the underlying securities. As a result, market fluctuations may cause it to vary. Furthermore, during market downturns, these companies may not issue dividends.

Choose The Right Hybrid Fund: Before selecting the suitable investment, ensure your financial goals and investment horizon align with the fund's objective. For example, hybrid funds may be excellent for investors with a five-year investment horizon. On the other hand, arbitrage funds are a good option if you want to earn a risk-free rate of return.

Also, with hybrid funds, you may achieve intermediate financial goals like buying a car or supporting higher education. Retirees also invest in balanced funds and choose a dividend to boost their post-retirement income.

Tax On Hybrid Funds

In hybrid Funds, the following tax is applicable.

On equity funds- Short term capital gains (STGC) are taxed at 15% Whereas Long term capital gains (LTCG) of more than 1 lakh are taxed at 10% without indexation.

On Debt Funds- The debt component of hybrid funds is taxable like other debt funds. For example, LTCG is taxable at 20% after indexation and 10% without indexation.

Frequently Asked Questions

Are Hybrid funds Good?

Investors who are hesitant to invest in equity funds should consider hybrid funds. This fund will lower the risk factor while also achieving optimal long-term returns. Investors are encouraged to invest in the best hybrid mutual funds or best-balanced funds to maximize their returns.

What Are Some Advantages Of Hybrid funds?

A few advantages that hybrid funds provide are- Diversification of funds, rebalancing of portfolio, active risk management, various risk tolerance funds.

What Comes Under Hybrid Funds?

There are different types of hybrid funds available under this category: aggressive hybrid fund, balanced advantage hybrid fund, conservative hybrid fund, Arbitrage fund, equity saving fund, etc.

Are Hybrid Funds Safe?

Yes, hybrid funds are much safer than equity funds. As a result, it is an excellent alternative and popular choice among conservative investors. However, it is easy for traditional investors to earn a stable income by allocating in balanced hybrid funds.

How Conservative Hybrid Funds Are Taxed?

Conservative hybrid funds are taxed similarly to other debt funds. Short-term capital gains are taxed at the individual's income tax slab rate. On the other hand, long-term capital gains are taxed at 20% with an indexation advantage.

What Are The Main Types Of Hybrid Schemes?

The term hybrid schemes mean a mix of equity and debt mutual funds. Hybrid schemes are divided based on asset allocation. When investing in a scheme, we all consider the risk and potential return. In general, stocks are seen as high-risk, high-reward investments. Hybrid schemes attempt to mitigate this risk by including debt into the portfolio. As a result, these schemes are classified according to their equity allocation.