Investors who want to combine equity and debt in their portfolio can invest in hybrid funds. Hybrid funds are designed for investors looking for a safer portfolio with capital appreciation and returns.
What are hybrid funds?
Hybrid funds invest in both equity as well as debt instruments. This mix is for diversification of funds, risk, and return.
Equity mutual funds invest in shares and stocks of other companies. It has the potential of higher return but also carries a high risk in comparison of debt mutual funds
Debt mutual funds invest in debt securities, treasury bills, corporate bonds. It provides a regular income to the investor and carries a low risk.
Both the mutual funds have their own pros and cons. Hybrid funds mix both the funds and aims to generate higher returns in exchange for lower risk depending on the investment goals of the investors.
Investors who are seeking good returns at moderate risk can invest in hybrid mutual funds
These funds are suitable for investors seeking good returns at moderate risk.
What are the types of hybrid funds?
Below are the types of hybrid funds depending on the asset allocation towards equity securities and debt instruments.
Equity-Oriented Hybrid Mutual Funds
Equity– oriented hybrid funds allocate more than 65% of the total fund in equity and rest in debt instruments and money market securities. This way the funds gain higher returns and less risk at the same time. Equity hybrid funds are also known as aggressive hybrid mutual funds.
Debt-Oriented Hybrid Mutual Funds
Debt oriented- hybrid funds allocate more than 65% of the total fund in fixed income debt instruments. Such as money market instruments like corporate bonds, government securities, treasury bonds, etc. The rest of the funds in equity i.e. shares and stocks of companies. Some portion is also invested in cash and cash equivalents to maintain liquidity. These funds are also known as conservative hybrid funds.
Balanced Hybrid Mutual Funds
Balanced fund is an open-ended scheme that invests in both equity and debt securities. They can invest a maximum of 40%-60% in equity and equity-related instruments and 40%-60% in debt instruments. The balanced fund is ideal for an investment horizon above three years. They are taxable like debt funds.
Dynamic Asset Allocation Funds or Balanced Advantage Funds
It is an open-ended dynamic asset allocation fund. This type of hybrid fund balances its asset allocation between equity and debt based on market situations. This balanced advantage fund books profit when markets rise and invest more during a correction. It is suitable for an investment horizon above three years. The funds are taxable as equity funds.
Multi-Asset Allocation Funds
It is an open-ended scheme investing in multiple asset classes. Multi-asset allocation funds can invest in a minimum of 10% of its assets in 3 asset classes. This hybrid mutual fund scheme is diversified in comparison to other hybrid funds as the investment is spread out to multiple asset classes. It is ideal for investors who want to invest for a three-year horizon.
Equity Savings Funds
It is an open-ended scheme investing in equity, debt, and arbitrage opportunities in the market. Equity savings scheme is permitted to invest a minimum of 65% of its assets in equities and 10% of its assets in debt securities. The ideal investment horizon for this hybrid mutual fund scheme is 2-3 years. For the purpose of taxation, they are considered as equity funds.
Monthly Income Plans
The monthly income plan is just like debt-oriented hybrid mutual funds. The majority of funds are invested in debt instruments. The idea is to provide a regular income to the investor through the dividend. The payout is at the will of the investor i.e. monthly, quarterly, annually or growth option. In case of growth option, the investor can choose to re-invest a portion or all of the return earned in the fund itself. This way the capital of the fund gets appreciated leading to higher returns.
These funds buy and sell the shares and stocks at the same time. Stocks are bought at a lower price from the cash market and sold in the future market at a higher price. The difference becomes profit. Arbitrage funds are relatively safer than equity hybrid funds.
How do they work?
There are 2 goals of any hybrid fund, capital appreciation in the long term and higher return in the short term. To achieve these 2 goals hybrid funds pick a mix of equity and debt.
Investing in equity provides capital appreciation and stability to the funds invested. Investment in debt instruments provides returns in the form of dividends and interests. Hybrid fund managers do asset allocation, market analysis, diversification of funds to ensure risk, return and capital appreciation are in place.
Asset allocation means allocating funds to different classes of assets available in the market i.e. bonds, bills, gold, etc.
Diversification of funds is a process in which the asset is chosen is such a manner to balance the risk and return matching the investment goals.
Why invest in a hybrid fund?
Equity mutual fund schemes provide returns with higher risk, ideal for investors who don’t mind taking the risk of capital and expect inflation-beating returns over the long term.
Debt mutual fund schemes offer regular and lower return with lower risk, ideal for investors who don’t want to take high risk and accept lower returns
Hybrid funds combine the risk and return both the funds offer and provide a blend of risk and return. The fund management involves risk management, portfolio diversification, and asset allocation. This is the reason why it is ideal for investors who look for a balance of risk and rewards.
Ways to Invest in hybrid mutual funds
The investment can be made in 2 ways, either through a lump-sum investment or SIP
Lump-sum investment- The entire investment amount is invested at once and returns start flowing thereon
SIP- The investor invests a fixed amount of his choice at fixed intervals. Here the benefit is that the investor can anytime change the lower or increase the amount of investment. An investor can also change the investment period from 6 months to say a year or end the investment.
One can calculate their potential mutual fund returns through different mutual fund calculators. For estimating SIP returns, one can use the SIP calculator. And for lumpsum returns, one can use the lumpsum mutual fund calculator.
Since Hybrid funds invest in both equities and debt securities, the tax treatment for these funds depends on the asset allocation of the funds. All hybrid funds with an exposure of 65% or more to equities are treated as equity funds. And the rest are treated as debt funds.
For mutual fund schemes, the holding period of investments is very important for tax purposes.
Equity Hybrid Fund
For an equity hybrid fund, if an investment holding period is less than one year, then it is a short term investment. And the gains arising out of it are Short Term Capital Gains (STCG). These are taxable at 15% per annum (plus 4% cess).
For investments with holding period for more than one year, then it is a long term investment. And the gains arising out of it are Long Term Capital Gains (LTCG). These are taxable at 10% per annum (plus 4% cess), only if the gains are above INR 1 lakh.
Debt Mutual Fund
For investments with holding period less than three years, are short term investments. And the Short Term Capital Gains (STCG) are taxable as per the income tax slab rate (plus 4% cess).
For investments with holding period more than three years, the Long Term Capital Gains (LTCG) are taxable at 20% with indexation benefit.
Additionally, there is a Dividend Distribution Tax (DDT) on dividend funds. From April 1st, 2020, dividends are taxable in the hands of investors. Dividends earned are subject to tax according to the income tax slab rate. Also, dividends above INR 5,000, attract 10% TDS.
Additionally, equity mutual funds are subject to securities transaction tax is 0.001% if investors sell their holdings.