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Aggressive hybrid funds- Meaning, things to remember and others

Aggressive Hybrid Funds
Aggressive Hybrid Funds

Introduction

Aggressive hybrid funds are a type of hybrid mutual fund scheme. They majorly invest in equity and equity related instruments. The debt allocation for these funds is between 20-35% of their assets. With such a portfolio, the performance of the fund gets difficult to assess. The equity investment brings significant returns to the portfolio, but at the same time, the impact of market volatility is high. The debt component can bring stability to the portfolio returns but can be prone to credit risk and interest rate risk. Hence investors need to be cautious before they invest in these funds. For the purpose of taxation, these hybrid equity funds are treated as equity funds and are taxed similarly.

What are aggressive hybrid funds?

Aggressive hybrid mutual funds are a type of open ended mutual funds that invest in both equity and debt securities. The exposure to equity is higher than debt funds. SEBI mandates an aggressive hybrid fund to invest between 65% to 80% of the total corpus in equity and equity related instruments. Also, debt allocation is between 20% to 35%. One can invest in aggressive hybrid funds through SIP route and lump sum route. 

Due to the high exposure to equity investments, the returns from these funds are greater than pure debt funds. At the same time, the risk associated with the funds is higher too. In a favourable market scenario, returns from these funds can be significant. At the same time, during unfavourable market conditions, the tables can turn around. Hence these funds are moderately high risk investments.

Also, the fund manager of the fund house plays an important role in these types of funds. The fund manager has the autonomy to design the investment strategy. They identify and invest in arbitrage opportunities to generate significant returns. Also, the stock selection varies from value to growth.

Therefore, the expertise and competence of the fund manager’s selection have a great impact on the returns.

These hybrid equity funds are treated as equity funds. Hence are taxed like equity mutual funds. For a holding period less than one year, the gains are taxable at Short Term Capital Gains rate of 15% (plus 4% cess). And for a holding period beyond one year, the gains above INR 1,00,000 per annum are taxable at Long Term Capital Gains rate of 10% (plus 4% cess). Also, from FY 2020-21, the dividends are taxable in the hands of the investors as per their income tax slab rate. Additionally, dividends above INR 5,000 are subject to TDS of 10%. Moreover, equity funds are subject to securities transaction tax (SST) of 0.001% if investors sell the units.

How do aggressive hybrid funds work?

Aggressive hybrid mutual funds are open ended equity oriented hybrid schemes. Predominantly they invest in equity and equity related instruments.

Aggressive hybrid funds have the flexibility to invest in arbitrage opportunities in the market. When a fund manager is able to buy a security at a low price from one market and able to sell it at a higher price in another market, it means he has used an arbitrage opportunity to earn profits. When a fund manager takes advantage of price differences of one security in two different markets, then it is called arbitrage.

Aggressive hybrid funds’ portfolio manager can opt for a growth or value style of investing while selecting stocks for the portfolio. On the other hand, while choosing debt securities, they can invest in both short and long duration papers or in varying sensitive investments, i.e., papers with both high and low interest rate sensitivity.

Aggressive hybrid funds earn returns majorly from their equity investments as they constitute the majority of the portfolio. The debt part of the portfolio offers stability to the portfolio. However, with equity being the major asset, the aggressive fund is affected by market fluctuations. The debt securities constitute only a small portion of the portfolio and fail to bring stability in the volatile markets.

One can invest in aggressive hybrid funds through SIP route and lump sum route. The investors can calculate their SIP returns and lumpsum returns using online return calculators.

Things to remember before investing

Investment goals

It is an excellent strategy to invest in a financial goal. Investing in a financial goal will help an investor be focused and disciplined towards investing. Also, it is essential to make sure that the investment objective of the fund is aligned with one’s goal. Therefore, wisely pick only those funds that match your investment goal.

Investment tenure

Aggressive hybrid funds have a major portion of their corpus in equities. Hence, they are highly volatile. Therefore, to generate significant returns, it is important to have a longer investment tenure. Longer investment durations will help to overcome the volatility risk.

Returns

Aggressive hybrid funds do not guarantee returns. Despite debt investments, these funds do not assure returns to investors. Also, change in interest rates will have an impact on the portfolio returns. Additionally, these funds generate above average returns in comparison to debt funds. This is because they have exposure to arbitrage opportunities.

Risk

Aggressive hybrid funds invest in both debt and equity. These funds have higher equity exposure and hence are more volatile. Also, they are categorised as moderately high risk investments. The fluctuations in the Net Asset Value (NAV) of the funds are lower in comparison to pure equity funds. Additionally, exposure to low quality debt instruments increases the risk levels of the portfolio.

Costs

The fund house charges fees for fund management. It is wise to consider funds with low expense ratios. Investing in a high expense ratio fund will lead to lower returns. Therefore, investors should consider the costs before selecting a fund.

Tax

For taxation purposes, aggressive hybrid funds are treated as equity funds. Short term capital gains (investments redeemed within one year) are taxable at 15%. At the same time, long term capital gains (investments redeemed after one year) are taxable at 10% for gains above INR 1,00,000 per annum. All gains below INR 1,00,000 are tax free.

Who should invest in an aggressive hybrid fund?

Aggressive hybrid funds invest a majority of their assets in equities. Therefore, a minimum investment horizon of 5-7 years is advised. These funds are prone to market fluctuations. They tend to give higher returns than conservative hybrid funds or balanced hybrid funds in market rallies. However, they are adversely affected when the market falls. Though they are considered better in terms of volatility than pure equity funds, the risk is still present.

Aggressive hybrid funds also invest a part of their portfolio in debt instruments. Though they are considered less volatile than equities, they are still prone to interest rate risk and credit risk. The falling or rising interest rate market scenarios can affect the portfolio. Similarly, the fund doesn’t put a restriction on the credit quality of the debt securities. The fund manager can invest in low rated securities to boost portfolio return, but the chances of default risk will be high.

Aggressive hybrid funds suit those investors who want to get a taste of market volatility but with moderate risk tolerance. Investors also need to have 5-7 years of the investment horizon. However, the investors need to understand that the risk in a fund also comes with the portfolio of equity. A portfolio with more weightage to mid cap and small cap stocks will be exposed to more risk than a portfolio with large cap stocks. Hence investors are advised to check the portfolio of the aggressive hybrid funds before they invest in them.

What are the fund categories under equity funds?

Equity mutual funds are a type of mutual funds that have an asset allocation of at least 65% of total assets in stocks. To invest in equity funds, one can follow the SIP investment route or lump sum route. The SIP investment route is the most preferred one as it allows investors to invest a little from their monthly income. One can calculate their SIP returns from investment using a SIP calculator. The categories under equity funds are:

  • Large Cap Fund
  • Mid Cap Funds
  • Large and Mid Cap Funds
  • Small Cap Fund
  • Multi Cap Fund
  • Value Funds
  • Thematic / Sector Funds
  • Equity Linked Savings Scheme (Tax saver funds)
  • Focused Funds
  • Dividend Yield Funds
  • Index funds

Conclusion

Aggressive hybrid funds are open ended equity oriented hybrid mutual funds. They majorly invest in equities (65-80%) and invest 20-35% in debt instruments. With a high equity investment and part debt investment, the fund’s performance is difficult to assess. The high equity component brings high returns and volatility to the portfolio. On the other hand, debt securities can be affected by credit and interest rate risk. But they can also provide stability to the portfolio.

Hence it is suggested that investors choose their asset allocation of equity and debt. And then choose the right funds to invest in each asset class.

Frequently Asked Questions

What are the fund categories under debt fund schemes?

Following are the types of debt funds:
1. Overnight Fund
2. Liquid Funds
3. Ultra Short Duration Fund
4. Low Duration Fund
5. Short Duration Fund
6. Money Market Fund
7. Medium Duration Fund
8. Medium to Long Duration Fund
9. Long Duration Fund
10. Credit Risk Fund
11. Corporate Bond Funds
12. Banking and PSU Fund
13. Dynamic Bond Funds
14. Gilt Fund
15. Floater Funds

What are the different types of hybrid schemes?

The following are the types of hybrid mutual funds:
1. Conservative Hybrid Fund (debt oriented scheme)
2. Balanced Fund or Aggressive Fund
3. Dynamic Asset Allocation Funds or Balanced Advantage Fund
4. Multi Asset Allocation Funds
5. Arbitrage Fund
6. Equity Saving Fund

Published on September 3, 2020