What is a hybrid fund? Types, Taxation, etc.

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Hybrid funds are funds that invest in multiple asset classes as per an investor’s financial objective. Hybrid funds are available for all types of risk profiles of investors. Hybrid funds mostly invest in two asset classes i.e. equity and debt. The following table contains all the points covered in the article.

1. What are hybrid funds?

A hybrid fund is a fund that invests in multiple asset classes like gold, equities, debt, etc. asset classes. This type of fund is suitable for new investors who have never invested in an equity mutual fund. This type of fund can be used as touching the water instead of diving directly into a pool for new investors. This is because the volatility in a hybrid fund is lower as compared to a pure equity-oriented mutual fund.

Asset allocation is an important part of financial planning to achieving financial goals for an investor, in a hybrid fund the fund manager himself looks after the same. The fund house offers different asset allocation plans to different risk profile types of investor and their investment objectives.

2. Hybrid funds types

a. Conservative hybrid funds

This type of fund invest 10 to 25% in equity & equity related instrument & 75 to 90% in debt & money market securities. This fund is best for investors who are totally new to the equity market. the volatility in the fund is much lower as a major part of the portfolio is invested in debt or fixed-income securities.

b. Dynamic Asset Allocation funds 

This fund is also called a balanced advantage fund. These funds are truly dynamic as a fund manager can fluctuate their asset allocation as per the market circumstances. When the valuation of equity instruments is higher the fund manager can divest from them and invest in debt and vice versa.

These funds are suitable for investors who want to invest for a period of at least five years or more.

Investors should look into the scheme information document (SID) before investing in this fund to know about the asset allocation and the proportion of equity & debt.

c. Equity Savings funds

These funds invest a minimum of 65% of they are investable capital in equities and equity-related instruments and a minimum of 10% in debt or debt-related instruments.

These funds are also allowed to hedge their position using derivatives, which results in lower volatility in returns. The goal of this fund is capital appreciation as well as income generation & they also have advantage taxation.

d. Multi-Asset funds

Multi-asset funds have to invest a minimum of 10% in three different asset classes for example gold, equities, real estate, etc. This fund is good for investors who want to invest beyond equity and debt.  

Different asset classes perform differently during, different market situations,  so having exposure to different asset classes can help diversify to risk in the portfolio.

e. Aggressive Hybrid funds

The aggressive hybrid fund invests 65 to 80% of its investable capital in equity or equity-related instruments &  20 to 35% in debt or money market instruments. This fund is also called a hybrid equity fund.

They are more volatile as compared to other hybrid funds but also provide greater returns than other hybrid funds. The investment objective of these funds is to provide capital appreciation with lesser volatility as compared to pure equity funds.

f. Arbitrage funds

This fund takes advantage of market irregularities to provide returns to its investors. For example, if a share of a company is traded at 50 rupees on NSE and 55 rupees on BSE, this fund would sell the stock in one market and buy in the other market to take the advantage of this irregularity. The arbitration opportunities may not be the same as those in the past for any fund.

This fund invests a minimum of 65% of its investable capital in equity and equity-oriented instruments and the rest in debt.  When there is are no arbitrage opportunities these funds usually invest their cash in debt instruments.

To learn more about types of the hybrid fund go to: www.miraeassetmf.co.in

3. Who should invest in a hybrid fund?

a. First-time investors

Legacy-wise, Indian investors are comfortable investing in fixed income securities so they may not be comfortable with volatility experience in equity or equity-related instruments. 

So they are better off starting to invest via a hybrid fund that has a small equity component and fixed income securities like debt instruments which will satisfy both of their objectives of regular income and capital appreciation.

b. Retired individuals

Retired individuals can also invest in hybrid funds to replace they are regular income via the hybrid schemes fixed income component, this fund also ensures that their purchasing power is not decreased due to inflation via the equity component of the fund.

c. Automatic Asset allocation 

Different asset classes like gold, real estate, equities, etc. perform differently during different phases of a market cycle. If an investor wants to allocate capital and diversify his risk,  he can invest in a hybrid fund where a fund manager will look after the asset allocation.

Also, read about this related topic: What is a liquid fund?

4. Advantages of hybrid fund

a. Risk diversification

A hybrid fund diversifies its portfolio in different asset classes for example equity, gold, real estate, etc. So it can provide better diversification than any other mutual fund. 

Also, all the asset classes perform differently during different phases of a market cycle, so the diversification can also reduce the volatility in the portfolio and help achieve relative greater returns

b. Relatively low risk.

As already discussed a hybrid fund is good for first-time mutual fund investors because it has a fixed income component which is relatively safer and less volatile as compared to pure equity funds. This fund can also make the first-time investor comfortable with the market volatility.

c. Fund for various investment needs & risk profiles.

Hybrid funds are available for various financial needs and for various investment risk profile investors. A conservative investor can invest in a conservative hybrid scheme,  where 75 to 90% of his portfolio will be invested in debt or debt-related instruments & 10 to 25% in equity or equity-oriented instruments.

An investor who wants to invest for 4 to 5 years in order to buy a car can invest in a conservative or arbitrage fund according to his own risk profile.

5. How to evaluate a hybrid fund

a. Expense Ratio

The expense ratio is the cost charged by an asset management company for providing professional service of managing funds. The lower the expense ratio the higher will be the return from the fund, so always check and compare the expense ratio before investing in any fund. A low expense ratio may not always achieve higher returns if the fund is not properly managed.

b. Historical Performance

An investor can check and analyze the past returns of a hybrid fund over a rolling period for example of 1,5, 10 years before investing, this can provide a good sense of how a fund performs against its benchmark.

c. Time Horizon

As there are six types of hybrid funds an investor should analyze his own risk profile and investment duration and his investment objective before investing in a hybrid fund and invest accordingly.

d. Investment Strategy

All hybrid funds have a different investment strategy and asset allocation policy so an investor should always read the scheme information document (SID) before investing and invest according to his financial objectives.

6. Hybrid funds taxation

a. Equity component

The equity component of a hybrid fund is taxed as per the rules of pure equity funds. The dividend received from the fund is clubbed in the income tax slab of an individual.

The gain up to ₹100000 rupees is tax-free and all the gain after that is taxed at the rate of 10% for long-term capital gains (i.e. holding period of more than 1 year).

If the fund is sold before the end of the first year, then short-term capital gain is charged at the rate of 15% for equity & equity-oriented instrumentals.

b. Debt component.

The debt component of a hybrid mutual fund is also taxed in the same way as a pure debt fund. If the investment is held for more than three years then the gain on the same is considered as long-term capital gain and is taxed at the rate of 15%.  

In case if the investment is sold before 3 years end, then the again on the same is called short-term capital gain and is clubbed up with the total income & taxed as per an investor’s income tax slab rate.

Disclaimer

I am not a SEBI registered investment advisor. This article is for information purposes any scheme or company name mentioned here is just for example & not a recommendation. 

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. The NAVs of the schemes may go up or down depending upon the factors and forces affecting the securities market including the fluctuations in the interest rates. The past performance of the mutual funds is not necessarily indicative of the future performance of the schemes. 

 

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