Hybrid funds are a type of mutual funds which invest in more than just one asset class, e.g. Equity and Debt. Sometimes they invest in a third or fourth asset class like Gold, Real Estate or International Equity. Hence, they are slightly different from Equity Mutual Funds or Debt Mutual Funds and have two separate fund managers.
Different asset classes generate returns in different market cycles. Hybrid funds combining equity and debt both, aim to give the best of both worlds to the investors….the returns of equity combined with low volatility of debt. They can rebalance their portfolio according to the market conditions and as such are ideal for certain investors and objectives.
Hybrid funds allocate equity and debt in various proportions in their portfolio. As such there are a variety of hybrid funds, but they can be broadly categorised as Equity Oriented Mutual funds and Debt Oriented Hybrid funds. The former has more equity allocation while the latter more debt.
Regulator SEBI, in their Oct 2017 circular has categorized hybrid funds in seven different categories for ease of identification. An AMC is allowed only one scheme per sub-category. This allows prospective investors to identify the relevant category ahead of scheme selection.
Conservative Hybrids Funds were earlier known as Monthly Income Plan or MIP. These plans allocate about 75% to 90% of portfolio in debt instrument and the balance in equities. The slight equity component aims to provide debt plus returns. Investors looking to invest in fixed income instruments but expecting slightly more return than fixed deposits or debt funds may consider investing here if their investment horizon is more than one year.
Balance Hybrid Funds invests 40% to 60% of their funds in Debt with the balance in Equity. As such they could be equity oriented or debt oriented or at other times have equitable distribution across these asset classes. Special utility funds like children funds, pension &retirement funds are often Balanced Hybrids.
Aggressive Hybrid Funds have a minimum of 65% exposure in equities and as such are Equity Oriented Hybrid funds. Depending on market conditions this equity exposure may be enhanced to 80% with the balance in debt instruments. Aggressive Hybrid Funds were formerly known as “Balanced Funds” and were a popular category. These funds aim generate equity type returns with lesser volatility than pure equity funds. However, with major investments in equity they are more volatile than pure debt funds and are ideal for investment horizons in excess of three years.
Aggressive Hybrid Funds are ideal for top financial goals where extreme volatility is best avoided, or for investing for the medium term or if you are new to equity markets and would like to acclimatise first.
Dynamic Asset Allocation Or Balanced Advantage Funds are dynamically managed funds and can shift between 100% debt to 100% equity. Like Aggressive Hybrids they provide a blend of equity & debt but unlike Aggressive Hybrids can be constantly rebalanced to suit market conditions.
In Balanced Advantage Funds, equity and debt allocations are constantly altered based on a pre-defined valuation strategy completely avoiding emotions in decision making. Market downturns & upturns are usually not predictable and these funds robotically allocate more equity during downturns and reduce equity exposure during upturns. The strategy adopted is buy low and sell high and keep doing this.
These funds are ideal for both the new investors in securities markets and also investors who wish to invest in equities but do not prefer the extreme volatility of equities. If you invest lumpsum in the markets and wish returns higher than debt but wish to limit your risks, this could be a good category to consider.
Equity Savings Funds allocate about a third of their assets in pure equities with the balance in debt and arbitrage. The fund management is conservative compared to Aggressive Hybrids or BAF. However, with equity and equity arbitrage these funds they are considered equity-oriented hybrid funds, hence, though offering low to moderate returns are taxed as equity schemes.
Multi-Asset funds true to their name are hybrid funds which invests in multiple assets. Apart from equity and debt, they also invest in Gold. Some funds invest in a fourth “asset class” like International Equity or Real Estate etc. As such these funds are more diversified than their other hybrid counterparts and reduce portfolio risk simultaneously attempting to profit from the fact that different asset classes behave differently in different phases of economy.
The simultaneous buying & selling of a security, currency or commodity in two different markets to profit from their price difference is referred to as Arbitrage. Arbitrage funds identify and try to profit from the difference in price of a share in cash market and derivative market. If the fund manager finds a stock priced differently in spot and futures market, he would seize the opportunity. This is a specialised but low risk activity and works best in volatile markets. Unlike pure equity funds where the focus is long-term investing, Arbitrage Funds do not need long term horizons but profit on opportunities only.
The balance portion of the funds are invested in high quality debt instruments. Arbitrage funds are considered as equity oriented mutual funds and are taxed accordingly. These funds are ideal for investors in high tax bracket looking for low risk investment options.
Hybrid Mutual Funds are an equally important category in the mutual fund space as are Equity Funds and Debt Funds. If you desire to have Debt plus returns but wish to avoid volatility of equity funds Hybrid Funds are an ideal choice. Depending on your investment requirement and tenure, you would need to select the relevant category. After identifying the category you should proceed to identify your favourite scheme within the category.
Disclaimer: Sudipta Sengupta, is an Insurance & Mutual Fund Distributor. He is not an Investment Advisor. Mutual Fund Series is not to provide any expert advice or provide exhaustive knowledge but just to share minimum relevant information to empower investors take decide independently.
Mutual fund investments are subject to market risks, read all scheme-related documents carefully from the earlier warning