Highlights
- Hybrid mutual funds are a type of mutual fund that can invest in more than one asset class.
- They are a combination of equity and debt assets and sometimes include gold or real estate.
- Hybrid funds follow three basic philosophies, asset allocation, correlation, and diversification.
Hybrid mutual funds are a type of mutual fund that can invest in more than one asset class. Most often, they are a combination of equity and debt assets and sometimes include gold or real estate.
Hybrid funds follow three basic philosophies, asset allocation, correlation, and diversification.
Asset allocation involves distributing funds across different asset classes; correlation refers to the synchronisation of returns between assets; and diversification refers to having multiple assets in a portfolio.
Assets within the same class often share similar risk sources and return factors, leading to a higher correlation in returns.
Conversely, assets within different classes typically have a lower correlation in returns. Combining assets with lower correlations can reduce portfolio risk.
What are the types of hybrid funds?
Multi-Asset Allocation Fund
These schemes require investments in at least three asset classes, with a minimum of 10 per cent invested in each asset class. These funds offer investors the opportunity to invest in a wider range of asset classes, and asset allocation is determined based on the fund manager’s perspective.
These schemes are required to invest at least 65 per cent and a maximum of 80 per cent in the equity asset class and 20 per cent to 35 per cent in the debt asset class. They offer the potential for higher returns at lower risk through a lower allocation to debt. They also benefit from the taxation applicable to equity-orientated schemes.
Dynamic Asset Allocation or Balanced Advantage Fund
These schemes are truly dynamic and can shift between 100 per cent debt and 100 per cent equity asset classes. Asset allocation is determined based on the recommendations of the financial model used by the fund. These funds are suitable for investors who want to automate their asset allocation.
Conservative Hybrid Funds
These schemes must invest 10-25 per cent of their assets in equity and related instruments. The remaining 75 to 90 per cent is invested in debt instruments. These funds aim to generate income from the debt component of the portfolio and maximise overall returns by using a small equity component. This is a good option for those who seek debt-plus returns and are willing to take on a little extra risk.
These funds strive to balance risk and return by investing in equity, derivatives, and debt. Derivatives reduce directional equity exposure, thereby reducing volatility and providing stable returns. Equity assets provide growth, while debt and derivatives provide regular, stable returns. These schemes invest 65 to 100 per cent in equity assets and 0 to 35 per cent in debt asset classes.
An arbitrage strategy involves buying in the cash market and simultaneously selling in the futures market to generate returns from the price difference between the two markets. This is done through derivative instruments, which are categorised as equity-orientated instruments.
Since the purchase and sale occur simultaneously, there is no directional call on the stock, and therefore, it does not suffer from the volatility of the equity asset class and provides stable debt-like returns. These schemes invest 65 to 100 per cent in equity assets and 0 to 35 per cent in debt asset classes. This fund is suitable for low-risk investors who want debt-like returns with equity taxation during periods of high volatility.
Hybrid Mutual Fund Taxation
Hybrid fund taxation depends on the proportion of equity and debt investments in the fund and the holding period of the investment.
Here’s a general overview of taxation:
Equity-orientated Hybrid Funds
These are hybrid funds with more than 65 per cent of their portfolio invested in equity shares. For tax purposes, they are treated like equity funds.
Short-Term Capital Gains (STCG)
If units of an equity-orientated hybrid fund are held for less than a year, any gains arising from the sale are taxed at a flat rate of 20 per cent.
Long-Term Capital Gains (LTCG)
If units of equity-orientated hybrid funds are held for more than a year, gains exceeding Rs 1.25 lakh in a financial year are taxed at 12.5 per cent without indexation.
Debt-orientated Hybrid Funds
These are hybrid funds where more than 65 per cent of the portfolio is invested in debt instruments. For taxation purposes, they are treated like debt funds.
Short-Term Capital Gains (STCG)
If units of a debt-oriented hybrid fund are held for less than three years, the gains are added to the investor’s taxable income and taxed as per the applicable income tax slab rates.
Long-term Capital Gains (LTCG)
If units of debt-oriented hybrid funds are held for more than three years, gains are taxed at 20 per cent with indexation or 10 per cent without indexation, whichever is lower.
Access to multiple asset classes from a single fund: A clear advantage of hybrid mutual funds is that instead of investing in different funds to meet different asset class needs, an investor can access multiple asset classes in a single product.
Active Risk Management: A hybrid mutual fund provides active risk management through portfolio diversification and asset allocation. They manage risk by combining non-correlated asset classes, such as equity and debt.
Diversification: They diversify portfolios not only within asset classes but also within subclasses within asset classes. Like an overall equity allocation, they invest in large-cap, mid-cap, or small-cap stocks, value, or growth stocks.
Catches Different Risk Profiles: These funds can offer different levels of risk tolerance, from conservative to moderate to aggressive. There are equity-orientated schemes for risk-takers, debt-orientated schemes for risk-averse investors, and dynamic asset allocation funds for those who don’t want to stick to a fixed asset allocation but instead want to move based on the market outlook without making decisions on their own. Arbitrage funds are for investors who want stable returns in volatile environments.
Buy low and sell high: Fund managers rebalance portfolios to adjust asset allocation within a set range, selling a particular asset class at a higher price and buying it at a lower price.
Automatic rebalancing: The fund manager rebalances the portfolio as needed, eliminating the need for investors to manually monitor the market and manage asset allocation.
(Disclaimer: The above article is meant for informational purposes only, and should not be considered as any investment advice. ET NOW DIGITAL suggests its readers/audience to consult their financial advisors before making any money related decisions.)
