Who Should Invest in Hybrid Funds & its Benefits?
Mutual fund investors can be broadly classified into three categories.
One, those who are ready to take some risk and they invest in equity
funds. Second, those who play it safe by investing in debt funds that
assures some returns while keeping money safe, and third, those who want
the best of both, by going for hybrid funds. This article covers the
following:
What is a Hybrid Fund?
Hybrid funds invest in both debt and equity instruments to achieve
diversification and avoid the concentration risk. A perfect blend of the
two offers higher returns than a regular debt fund while not being as
risky as equity funds. The choice of a hybrid fund depends on your risk
preferences and investment objective.
How Do Hybrid Funds Work?
Hybrid funds aim to achieve wealth appreciation in the long-run and
generate income in the short-run via a balanced portfolio. The fund
manager allocates your money in varying proportions in equity and debt
based on the investment objective of the fund. The fund manager may
buy/sell securities to take advantage of market movements.
Who Should Invest in Hybrid Funds?
Hybrid funds are considered a safer bet than equity funds. These
provide higher returns than genuine debt funds and are popular among
conservative investors. Budding investors who are willing to get
exposure to equity markets may invest in hybrid funds. The presence of
equity components in the portfolio offers the potential to earn higher
returns. At the same time, the debt component of the fund provides a
cushion against extreme market fluctuations.
In this way, you receive stable returns instead of a total burnout
that may happen in case of pure equity funds. For the less conservative
category of investors, the dynamic asset allocation feature of some
hybrid funds becomes a great way to enjoy the best out of market
fluctuations.
Types of Hybrid Funds
Hybrid funds are further classified based on their asset allocation.
Some hybrid funds have a higher equity allocation, while others allocate
more towards debt. Let’s have a look in detail:
Equity-oriented hybrid funds If the fund manager
invests more than 65% of the fund’s assets in equity and the rest in
debt and money market instruments, then it’s called an equity-oriented
fund. The equity component of the fund comprises of equity shares of
companies across industries such as FMCG, finance, healthcare, real
estate, automobile, and so on.
Debt-oriented balanced funds
A hybrid fund is termed as a debt-oriented fund if the fund manager
allocates more than 65% towards debt instruments. The debt component of
the fund constitutes the investment in fixed-income havens such as
government securities, debentures, bonds, treasury bills, and so on. For
the sake of liquidity, some part of the fund would also be invested in
cash and cash equivalents.
Monthly Income Plans
These are hybrid funds that invest predominantly in debt instruments. A
monthly income plan (MIP) would generally have 15-20% exposure to
equities. This would allow it to generate higher returns than regular
debt funds. MIPs provide regular income to the investor in the form of
dividends. Investors can choose the frequency of dividends payout; it
can be monthly, quarterly, half-yearly, or annually. MIPs also come with
the growth option – they let the investments grow in the fund’s corpus.
Hence, an MIP is not a small monthly income investment. Do not let the
name mislead you. They are hybrid funds that invest mostly in debt and
some amount of equities.
Arbitrage Funds An
arbitrage fund manager tries to maximise returns by buying the stock at a
lower price in one market. He then sells it at a higher price in
another market. However, arbitrage opportunities are not always
available quickly. In the absence of arbitrage opportunities, these
funds might stick to debt instruments or cash. By design, arbitrage
funds are relatively safer, like most debt funds. But its long-term
capital gains are taxable like that of any equity fund.
Things an Investor Should Consider
Risk factor It would not be wise to assume
hybrid funds to be completely risk-free. Any instrument which invests in
equity markets will have some risk. It might be less risky than pure
equity funds, but you need to exercise caution and portfolio rebalancing
regularly.
Return Hybrid funds don’t offer
guaranteed returns. The performance of underlying securities affects the
Net Asset Value (NAV) of these funds. So, it may fluctuate due to
market movements. Moreover, these might not declare dividends during
market downturns.
Cost Hybrid funds would
charge a fee for managing your portfolio, which is known as the expense
ratio. Before investing in a hybrid fund, ensure it has a low expense
ratio than other competing funds, and this translates into higher
take-home returns for the investor.
Investment Horizon
Hybrid funds may be ideal for a medium-term investment horizon, say
five years. If you want to earn a risk-free rate of return, you may go
for arbitrage funds. They bet on price differentials of securities in
different markets.
Financial Goals You can
meet intermediate financial goals like buying a car or funding higher
education with hybrid funds. Retirees too invest in balanced funds and
go for a dividend option to supplement their post-retirement income.
Tax on Gains
The equity component of hybrid funds is taxed like equity funds.
Long-term capital gains over Rs.1 lakh on equity component are taxed at
the rate of 10%. Short-term capital gains (STCG) on equity component are
taxed at the rate of 15%. The debt component of hybrid funds is taxable
as any other debt fund. You must add these gains to your income and
taxed as per your income slab. LTCG from debt component is taxable at
20% after indexation and 10% without the benefit of indexation.
Top 5 Hybrid Funds in India
While selecting a fund, you need to analyse the fund from various
perspectives. Various quantitative and qualitative parameters can tell
you which is the best hybrid fund that suits you. Additionally, you need
to keep your financial goals, risk appetite, and investment horizon in
mind.
For more information on this, visit TAXAJ
Posted by Aashima
Team TaxaJ
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