Keeping in mind the risk tethered to them, investments can be classified as high-risk (or equity) investments, low-risk (or debt) investments, and hybrid investments. When investing, investors are advised to only invest in securities that match their financial goals, their ability to tolerate risk, and the time frame they wish to allocate to their investments. Different investors have different goals owing to which it is hard to classify them as solely high-risk or solely low-risk takers. It is against this backdrop that hybrid mutual funds gain credence.
Defining Hybrid Mutual Funds
Hybrid mutual funds can be defined as mutual funds that seek to create balanced portfolios by offering regular income to investors in addition to capital appreciation over a longer time frame. Fund managers responsible for hybrid mutual funds create a portfolio keeping in mind the objective of the scheme and allocate the funds in equity as well as debt instruments to varying degrees. Furthermore, the fund manager is responsible for buying and selling assets in the event of favourable market movements.
Examining Profiles Best Suited to Invest in Hybrid Mutual Funds
Hybrid mutual funds are understood to be riskier investments in comparison to debt funds however they are still safer than equity funds. These funds are more likely to offer superior returns in comparison to debt funds and are popular among several low-risk investors. Moreover, those new to investing who are uncertain about equity markets often gravitate towards hybrid mutual funds. This is owed to the fact that these funds have a debt component that
provides a layer of stability while also providing modest exposure to equity. Hybrid mutual funds, therefore, allow investors to gain the most from equity investments while providing them with a safety net against extreme volatility that arises in the markets.
Types of Hybrid Funds
Hybrid mutual funds can be classified as follows.
Equity-Oriented Hybrid Funds
These funds direct 65 percent – if not more – of their total assets towards equity and equity-related instruments belonging to companies that span varied market capitalizations and sectors. The remainder of their assets i.e., 35 percent or less, is directed towards investments made in debt securities as well as money market instruments.
Debt-Oriented Hybrid Funds
This form of hybrid funds invests a minimum of 60 percent of its total assets in fixed-income securities. These securities include but aren’t limited to debentures, bonds, and government securities. The remainder of the total assets i.e., 40 percent is directed towards equity investments. Certain funds may also channel a small portion of their capital towards liquid schemes.
Balanced hybrid funds direct at least 65 per cent of their total assets to equity and equity-related investments and the remainder of their total assets are invested in debt securities and cash. From a tax perspective, income drawn from such funds falls under equity funds and has a tax exemption applicable to long term capital gains of up to INR 1 lakh. The fixed income aspect of these kinds of hybrid funds makes them ideal for equity investors as balanced funds limit the volatility that equity investments bring with them.
Monthly Income Plans
This kind of hybrid fund primarily invests in fixed-income securities. A small portion of this fund’s total assets is directed toward equity and equity-related instruments. Owing to this fact, these plans are able to accrue superior returns in comparison to pure debt schemes. Monthly income plans provide their investors with a regular income stream. Growth options are available under monthly income plans and revolve around the income growing under the fund’s corpus.
This kind of hybrid mutual fund operates by buying stocks for a lower price in one market and selling them for a higher price in another market. This kind of fund’s fund manager is on the lookout for arbitrage opportunities at all times such that she/ he can maximize the fund’s returns. That being said, there are occasions during which good arbitrage plans aren’t available. In such scenarios, the fund directs its assets towards debt securities and cash. Arbitrage funds are understood to be as safe as debt funds. That being said, long-term capital gains drawn from this kind of hybrid fund are taxed in the same manner as equity funds.
Prior to investing in hybrid mutual funds, it is important to consider the following factors.
The Risk-Return Assessment
Investors must take a careful look at the portfolio of the scheme under consideration in order to determine what the risks are.
Selecting the Appropriate Hybrid Fund
Different individuals are able to withstand risks to varying degrees and have different financial goals and investment horizons. Prior to investing in a hybrid fund, it is important to understand which kind of hybrid fund best matches your profile.
Long-term capital gains drawn from hybrid funds that account for more than INR 1 lakh are taxed at 10 per cent without indexation whereas short-term capital gains are taxed at 15 per cent.