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Hybrid Funds – Different Types, Definition and Advantages

Highlights

  • What are hybrid funds, their types and how should you choose from these funds?
  • All that and more is explained in this post. Read on to know the same!

Mutual funds can be classified into three types – equity, debt and hybrid. Equity funds invest in shares and debt funds invest in bonds, government securities and money market instruments. There are many investors who do not want to invest their entire money in equity funds and there are some who do not want to invest everything in debt. They are looking for an ideal combination of both equity and debt basis their risk profile and goals. Hybrid funds are the solution for them, let us understand more.

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What are Hybrid Funds?

As the name suggests, hybrid funds are a mix of the two-they can invest in both equity and debt. If you want to have the flavour of both equity and debt without compromising on your risk profile and investment objective, hybrid funds fit the bill. There are various kinds of hybrid funds which follow different investing methodologies-some invest more in equity than in debt and vice-versa. You can choose the fund with the right proportion based on your risk appetite and goals.

What are Different Types of Hybrid Funds?

Hybrid funds have been classified into seven different categories by SEBI, let us understand each category of hybrid funds:

Aggressive Hybrid Funds

As the name suggests, these funds are managed aggressively with a higher allocation to equity. As per SEBI regulations, these funds have to invest a minimum of 65% in equity shares and 20% in debt, the rest 15% can be invested as per fund the manager’s discretion in either equity or debt. Thus, these are considered as equity mutual funds from a taxation perspective since any fund which holds minimum 65% equity is classified as an equity mutual fund. To know the best performing aggressive hybrid funds you can read another post of ours – https://www.wishfin.com/mutual-fund/five-best-performing-aggressive-hybrid-funds-to-invest-in/.

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Conservative Hybrid Funds

Conservative hybrid funds are managed keeping in mind a risk-averse investor. These funds majorly invest in debt securities such as corporate bonds, commercial papers, government securities, money market instruments. As per SEBI regulations, minimum 75% of the portfolio should be in debt and 10% in equity. The rest 15% allocation can be done by the fund manager basis his/her discretion. If the fund manager feels that equity will do better, then this 15% is allocated to equity and vice-versa. To know the best performing conservative hybrid funds you can read another post of ours – https://www.wishfin.com/mutual-fund/five-best-performing-conservative-hybrid-funds-to-invest-in/

Equity Savings Hybrid Funds

Equity Savings hybrid funds are a type of hybrid funds that invest in a mix of equity, arbitrage and debt. Basis the SEBI regulations, they have to invest a minimum of 65% in equities (including an allocation to arbitrage) and a minimum 10% in debt. These funds follow a flexible approach of rebalancing the portfolio between equity, arbitrage and debt basis the fund manager’s view on markets and the economy. To know the best-performing equity savings hybrid funds you can read another post of ours – https://www.wishfin.com/mutual-fund/five-best-performing-equity-savings-hybrid-funds-to-invest-in/

Arbitrage Funds

Arbitrage funds are different from all other hybrid funds in the way they are managed and generate returns. These funds follow a strategy of buying and selling stocks in the cash and futures market, thereby generating returns from the difference in the price of the stock in the cash and futures market. The returns from arbitrage funds are more like liquid funds and you should have a mindset of a debt investor when investing in these funds. They are relatively safer than debt funds since they do not carry any interest rate or credit risk. Also, these funds carry a lower tax burden for the investor since for taxation they are treated as equity funds. To know the best performing arbitrage funds, you can read another post of ours – https://www.wishfin.com/mutual-fund/three-best-performing-arbitrage-funds-to-invest/

Dynamic Asset Allocation Funds

These funds invest in a mix of equity, debt and arbitrage. The portfolio is dynamically managed and rebalanced based on different criteria such as PE (Price to earnings) or PB (price to Book). These funds have an inbuilt model where allocation changes between equity, arbitrage and debt. To know the best performing dynamic asset allocation funds, you can read another post of ours- FIVE BEST PERFORMING DYNAMIC ASSET ALLOCATION FUNDS.

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Balanced Hybrid Funds

These funds are mandated to invest 40-60% in equity and the rest in debt. These are among the least popular and invested categories of hybrid funds since they qualify for debt taxation, which is much higher than equity taxation. To be classified as an equity fund from a taxation point of view, a fund should invest a minimum of 65% in equity. These funds fall short of that.

Multi-asset Allocation Funds

These funds are mandated to invest a minimum 10% in at least three asset classes. These three asset classes can be equity, debt, gold or real estate. The rationale behind these funds is to have the flexibility to invest the maximum in an asset class, which is expected to perform best. However, in practice, most of these funds hold at least 65% in equity to avail of the taxation benefit. Therefore, these are not truly managed like multi-asset allocation funds with less allocation to other asset classes. Also, the nature of these funds makes them over diversified across asset classes which means they would never be chart-toppers since all asset classes rarely do well together.

Which Hybrid Fund Category is the Best?

The answer to this question depends on various factors and could vary for every individual. These are the factors one should keep in mind before investing in any category of hybrid funds:

Risk Profile – If you are risk-averse and conservative but are looking for slightly higher returns than a debt fund by small participation in equity, conservative hybrid funds are best for you. They can deliver that extra 1-2% return over a debt fund. However, if you have a moderate to an aggressive risk profile but do not want to invest 100% in equity then aggressive hybrid funds, equity savings hybrid funds and dynamic asset allocation are the best options. Among the three, we would recommend dynamic asset allocation funds. If you want a completely risk-free option with lower returns, arbitrage funds are the best choice for you.

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Tax Benefit – Hybrid funds, which are classified as equity funds from a taxation perspective, are naturally a better option. Aggressive hybrid funds, equity savings hybrid fund and arbitrage funds score on this point over other categories.

Time Horizon – If your time horizon is 6 months-3 years then arbitrage funds are the best option. If your time horizon is 3-5 years, you can invest in conservative hybrid funds, and if you are looking to invest for more than 5 years, all other categories are suitable for you. Please do not look at the time horizon in isolation but also include the other parameters mentioned to decide on the best hybrid fund for you.

Returns – If you are happy with lower, liquid fund kinds of returns, arbitrage funds are the best option. For a return expectation higher than arbitrage, one can invest in conservative hybrid funds. If your return expectation is more like equity, you can invest in aggressive hybrid funds or equity savings hybrid funds.

Conclusion

Hybrid funds are a popular category of mutual funds with many investors who have reposed their faith in them. Over the years, hybrid funds have been an ideal choice of new investors in mutual funds. These are the right funds to start investing when you do not know how debt & equity markets work. These funds also provide you an automatic asset allocation that you might not be able to do yourself. New categories of hybrid funds such as dynamic asset allocation are good strategies for riding the vagaries of markets. We recommend investing in hybrid funds keeping the above-mentioned factors in mind and one can avoid balanced hybrid funds and multi-asset allocation funds.

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