What Are Hybrid Funds: Meaning, Types and Benefits

 

In this policy, the investment risks in the investment portfolio is borne by the policyholder

Investors can choose from many different types of mutual funds. Among the different mutual funds, hybrid funds stand out as a versatile option offering a blend of different investments. These funds combine the features of equity and debt funds, providing investors with a diverse portfolio under one roof. Moreover, there are several different types of hybrid funds to choose from.

Here in this article, we will deep dive into the hybrid fund meaning, features, types, tax implications and more.

What Do Hybrid Funds Mean?

A hybrid fund is a type of mutual fund which invests in more than one asset class. It can be a combination of equity and debt, equity and gold, real estate or it can be a mix of three. Each hybrid mutual fund scheme has a different investment objective based on which the asset allocation and proportion are set.

Features of a Hybrid Fund

Here are some of the key features of hybrid funds:

• A Mix of Asset Classes:

A hybrid mutual fund invests in a portfolio which is a mix of more than one asset class. This enhances diversification not only within a single asset class but also in two or three asset classes.

• Well-Balanced:

The portfolio of a hybrid mutual fund is well-balanced as it gets exposure to various asset classes. Hence, it is considered one of the most appropriate investment options for investors with moderate risk appetite. Furthermore, it is one of the most balanced investment options for individuals who are in their 40s when the risk tolerance is neither too high nor too low.

• Excellent for the Long Term:

A hybrid fund investment is considered one of the best investment options for long-term and medium-term investors i.e. a minimum of four to five years. In an equity-debt hybrid fund, the equity component helps in capital appreciation and the debt component offers a stable return. This ensures good long-term performance.

Different Kinds of Hybrid Mutual Funds

Hybrid funds can be classified into various types based on their asset allocation, which are as follows:

1. Aggressive Funds:

Equity-oriented hybrid funds or aggressive funds are those that primarily invest in equity. A minimum of 65% of its total AUM (asset under management) has to be invested in equity and equity-related instruments. There is no barrier to market cap or sector; it can invest in any company across any sector with different market caps. While the remaining 35% of its AUM is invested in debt or money market instruments.

2. Conservative Funds:

Also called debt-oriented funds, these primarily invest in fixed-income instruments such as bonds, government securities, debentures etc., for risk mitigation. A minimum of 60% has to be in debt instruments while the remaining 40% in equity or equity-related instruments for capital appreciation.

3. Arbitrage Funds:

Arbitrage means making gains by leveraging the price difference in two or more markets by buying from one market and selling in another at a higher price. Arbitrage funds purchase stocks from the cash market and sell them in the futures market at a higher price by leveraging price differences. However, when there are no available arbitrage opportunities it primarily invests in debt instruments.

4. Balanced Funds:

Typically, the equity and debt components in these funds range between 40% and 60%. So a balanced fund can be 40% in equity and 60% in debt or vice versa or it can be any combination in between. The fixed-income instrument components help the investor to mitigate the risk associated with equity investment along with capital appreciation.

5. Equity Savings Funds:

These hybrid mutual funds aim to lower the risks of equity investments by investing in equity, derivatives and debt instruments besides stocks. Using derivatives, these hybrid funds aim to hedge risky positions, reducing volatility and delivering more stable returns.

6. Multi-Asset Allocation Funds:

These hybrid mutual funds invest in at least three different asset classes. Besides equity and debt, these funds also invest in gold instruments for hedging and protection against the effects of inflation. At least 10% of the fund’s total AUM must be invested in each asset class.

7. Dynamic Asset Allocation / Balanced Advantage Fund Funds:

The main aim of these hybrid funds is to provide a great deal of flexibility to fund managers. Their asset allocation is dynamic, i.e., it can be changed from 100% equity to 100% debt and anything in between.

There is another similar option available in the market, known as the Unit Linked Insurance Plan (ULIP). It is a combination of both insurance and investment; it allows policyholders to invest in a mix of equity, debt, or a combination of both assets, while also providing life insurance coverage. Moreover, ULIPs offer flexibility, as investors can switch between different funds based on their risk appetite, market conditions or changing financial goals.

How Does a Hybrid Fund Function?

A hybrid mutual fund primarily invests in two asset classes, sometimes three. Most of the time, it invests in equity and debt which makes a balanced portfolio. The equity component of the portfolio helps in capital appreciation. On the other hand, the debt component provides stable returns and helps to mitigate the volatility risk of equity investments.

The stable returns generated from debt investments act as a cushion when the market is underperforming. Also, the equity-debt combination has a lower correlation; therefore, the combination becomes the most balanced compared to other asset class combinations and reduces the overall risk of the portfolio.

Who Should Consider Investing in Hybrid Funds?

Hybrid mutual funds may be appropriate for different types of investors due to their flexibility and diversification. Here are the types of investors who can consider investing in a hybrid mutual fund:

• Newbie Investors:

A hybrid mutual fund can be a perfect investment option for a newbie investor who is investing in a mutual fund for the first time. As it acts as a combination of an equity fund and a debt instruments with a low to medium level of risk, depending on the type. Also, it provides an entry to the equity market for first-time investors so that they can slowly and gradually understand the market.

• Medium-term Investors:

Hybrid funds are also appropriate for investors who have a medium-term investment period like 3 to 5 years. This is mainly due to the fact that the volatility risk in a hybrid fund is usually low compared to an equity mutual fund.

• Retired Persons:

A debt-oriented hybrid fund can be suitable for a retired individual as the volatility risks in such types of funds are low and it helps to generate stable returns without any major fluctuation.

• Short-term Investors:

An arbitrage or a conservative fund can be an appropriate investment option for an investor who is looking to park his or her fund for less than a year.

Tax Effects of Hybrid Funds

When it comes to tax implications, hybrid funds are categorised into two types: Equity-oriented schemes and other schemes. The funds with a minimum of 65% of its total assets in equity and equity-related instruments will be taxed under equity-oriented schemes and all other remaining schemes will be treated as other schemes.

For Equity Oriented Schemes:

• Long-Term Capital Gains (LTCG): Any equity-oriented hybrid fund will qualify for LTCG if held for more than one year. A LTCG of 10% (without indexation benefit) will be applicable over and above gains of Rs. 1 lakh i.e. up to Rs. 1 lakh is tax-free in a financial year.
• Short-Term Capital Gains (STCG): Any equity-oriented hybrid fund will qualify for STCG if held for less than a year. A STCG of 15% will apply to the capital gains.

For Other Schemes:

The taxation of schemes other than Equity Oriented Schemes have undergone a change w.e.f April 1, 2023 and hence these mutual funds if purchased after April 1, 2023 will not be eligible for indexation benefit & will be chargeable to tax at the applicable rates to the taxable person instead of 20% (as applicable earlier).

Taxability if purchased before April, 1, 2023 -

• Long-Term Capital Gains (LTCG): A hybrid fund held for a period of more than 3 years (36 months) will qualify for LTCG and the gains will be taxed at 20% after indexation.
• Short-Term Capital Gains (STCG): A hybrid fund held for a period of less than 3 years (36 months) will qualify as STCG. The gains will be added to the income and taxed at per applicable slab rates.

Taxability if purchased after April, 1, 2023 -

For all the mutual funds (except equity oriented mutual funds) any gains irrespective of holding period will be deemed to be short term capital gain and tax will be levied at applicable slab rate. 

Conclusion

To conclude, hybrid funds are also offered under Unit Linked Insurance Plans which allocates assets in more than one asset class. The combination of asset classes such as equity, debt, and money market funds, depends on your risk appetite and investment goals. Usually, most hybrid funds come with an equity-debt asset mix; this combination is one of the well-balanced with the lowest correlation.

If you are a first-time investor, a short-term investor or a conservative investor, you can consider investing in hybrid funds. However, consider reading the Key Information Memorandum of the scheme to make an informed decision.

FAQs on Hybrid Funds

1. What is a hybrid fund?

A hybrid fund is a type of mutual fund which invests in more than one asset class. The asset mix can be within equity, debt, gold or real estate. Usually, most hybrid funds invest in equity and debt instruments.

2. Which hybrid fund is best to invest in?

There are several top-performing hybrid funds you can choose from. Some of the top-performing hybrid funds have generated a 3-year return ranging from 20% to 30 % CAGR. Besides past returns, consider factors like your risk appetite, investment horizon, fund manager’s experience, investment objectives, and new tax rules effective from April 1, 2023, before investing.

3. What are the advantages of hybrid funds?

Some of the advantages of a hybrid fund are: it offers a well-diversified investment and it is appropriate for most all types of investors be it a short/medium/long term investor, senior citizen investor or even a first-time investor.

4. What is the return rate of a hybrid fund?

The rate of return for hybrid funds varies based on the market condition as there is an equity component associated with it. It also varies with the performance of the assets held in the fund’s portfolio. Usually, hybrid funds tend to offer more returns than debt mutual funds.

5. Are hybrid mutual funds good or bad?

A hybrid fund can be a great investment option for investors with low to medium risk tolerance or for an individual in his/her 40s or senior citizens. It can even be appropriate for a first-time investor offering him/her an entry point to equity.

ARN - ED/04/24/10771