Ignore Hybrid Funds At Your Peril

Hemant Rustagi
Chief Executive Officer, Wiseinvest Pvt Ltd.

Mutual funds have emerged as an effective investment vehicle for investors with varied risk-taking capacity and time horizon to practice asset allocation. If you are looking to invest in a combination of both debt and equity, Hybrid Funds should be an integral part of your portfolio. Hybrid funds not only allow you to choose the appropriate ones in line with your investment objectives but also enable you to retain control on how much money should be invested into each of the asset classes during your defined time horizon. Simply put, you can create a portfolio that suits your risk profile and investment objectives. However, choosing the right combination of hybrid funds can be a little tricky as there are six types of funds with a different asset mix. Here is a brief description of each category and what do they offer:

Conservative Hybrid Funds — Conservative hybrid funds invest around 75-90 per cent in debt instruments and the rest in equity. These funds can be a good option if you are looking to earn slightly higher returns than fixed deposits and pure Debt Funds without taking too much additional risk. The minimum time horizon for investing in these funds should be three years. These are considered as debt funds for tax purposes: any capital gains on units redeemed within three years will be considered as short-term capital gain and taxed at your nominal tax rate. Any capital gain on units redeemed after three years will be considered as long-term capital gain and taxed at 20 per cent after indexation.

Balanced Hybrid Funds — There are two sub-categories here. First, funds that invest 40-60 per cent in debt securities and the rest in equities. These funds have the potential to provide higher returns than conservative hybrid funds, albeit with higher volatility. Then, there are aggressive hybrid funds that invest 65-80 per cent in equities and the rest in debt instruments. The ideal time horizon for investing in these funds would be 3-5 years and more. For tax purposes, these are considered as equity funds: capital gain on units redeemed within one year will be taxed at 15 per cent and beyond one year will be considered as long-term capital gains and taxed at 10 per cent. 

Dynamic Asset Allocation/Balanced Advantage Funds — Dynamic asset allocation funds manage allocation to different asset classes dynamically. Balanced advantage funds are those that usually invest in a combination of equity, arbitrage and debt in a manner that equity and arbitrage allocation is 65 per cent or more. These are ideal for you if you want equity allocation to be rebalanced in line with the market levels and earn higher pre and post-tax returns in comparison to balanced hybrid funds.

Multi Asset Allocation Funds — These funds invest in at least three asset classes with a minimum allocation of at least 10 per cent each in all three asset classes. Ideally, the time horizon should be the same as in the case of aggressive hybrid funds.

Arbitrage Funds — An arbitrage fund seeks to generate income through arbitrage opportunities emerging out of mis-pricing between the cash market and the derivates market. In other words, arbitrage funds capture the ‘interest’ element in the equity market and offer an opportunity for investors to earn healthy returns without taking an equity market exposure. These funds invest in stocks and their futures simultaneously and hence eliminate the risk of volatility normally associated with equity funds. Besides, arbitrage funds score over income funds in terms of tax efficiency as tax benefits of equity funds are applicable to these funds.

Equity Savings Funds — Equity savings funds usually invest around 20-25 per cent in equities, 40-45 per cent in arbitrage and the rest in debt instruments. These funds can be a better option than conservative hybrid, both in terms of pre and post-tax returns. The ideal time horizon for investing in these funds would be three years and more.