All Hybrid Funds are not the same: Know the difference
Hybrid Funds can be ideal for investors who are investing in equity for the first time or do not want to take active decisions on their asset allocation themselves. Choose a fund which suits your risk profile, time horizon and goals.
Feb 2024
4 mins read
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As the name suggests, Hybrid Funds invest in a mix of equity and debt to provide an optimal mix of diversification. However, there are six categories of Hybrid Funds and understanding the nuances of each category is essential to make an informed choice while investing in these funds. Let us take a look at the these categories.
- Balanced Advantage Funds/Dynamic Asset Allocation FundsThese funds have the in-built flexibility to tweak their asset allocation in equity and debt based on a pre-determined formula such as Price to Earnings Per Share (P/E), and other filters. If the markets are expensive/valuations are expensive, these funds reduce their equity exposure and vice-versa. Thus, by actively managing the equity and debt exposure these funds manage to contain the downside at the same time participate in equity upside. They typically invest 65% in equity which qualifies them for equity taxation. Investors should have at least 3 years of time horizon while investing in this category.
- Aggressive Hybrid FundsThese funds invest in the range of 65% to 80% in equities*(equities and derivatives) and 20% to 35% in Debt instruments. This helps you participate in the equity upside along with an allocation to debt instruments, providing stability. Just like BAFs, these funds also offer equity taxation. Some funds in this category also invest in international equities, which adds an extra layer of diversification to your portfolio. Investors should have more than 3 years of investment horizon in these funds.
- Multi Asset FundsAs the name suggests, these funds invest in three asset classes which are typically equity, debt and gold/silver. These funds are mandated to invest at least 10% each in these three asset classes, respectively. So a fund may choose to allocate largely towards equity, debt or other asset class depending on the outlook and opportunity. When the outlook for equities is gloomy, the fund manager may increase exposure to gold and debt. Gold tends to do well as investors rush for safety when economic growth is anticipated to slow down. For instance, gold delivered double digit return during 2019-2020 Corona virus pandemic. Thus, Multi Asset Funds give you diversification through three asset classes. Investors should have at least three years investment horizon while investing in these funds.
- Balanced Hybrid FundsBalanced Hybrid Funds invest in the range of 40% to 60% in equities and 40% to 60% in debt. As you can see, the maximum exposure to equity is restricted at 60%. So unlike Debt Funds, Balanced Hybrid Funds qualify for indexation benefit. Gains realized after three years are taxed at 20% with indexation benefit. (A minimum of 65% assets in equity is required for any fund to qualify for equity taxation.) Investors should have at least three years of investment horizon in these funds.
- Equity Savings FundEquity Savings Funds invest in a mix of equity, debt and arbitrage in a manner which keeps the fund’s equity exposure at 65%, helping you get equity taxation. The 65% equity exposure is achieved through arbitrage strategy. Such funds can be ideal for investors who have a relatively low risk appetite and still wish to invest in equity. These funds can be ideal for first-time equity investors.These funds can also be used in circumstances where you are not willing to invest lumpsum in equity. You can invest a lumpsum in an Equity Saving Fund and initiate a Systematic Transfer Plan (STP) into an equity fund. This could ensure that a large portion of your corpus is protected, allowing you to not completely miss out from equity.
- Arbitrage FundsArbitrage Funds are equity-oriented hybrid funds that employ arbitrage strategies by exploiting price differential in derivatives and cash market by simultaneously buying and selling in cash and futures market. When such opportunities are not available, fund managers invest in short term debt securities or money market instruments. These funds are taxed similar to equity funds. Investors looking for slightly more returns than Liquid Funds can consider Arbitrage Funds. These funds typically carry low risk and are ideal for parking funds for six months to two years.
Conclusion
Hybrid Funds have the flexibility to invest across Large, Mid and Small Cap stocks. However, a majority of these funds have their asset allocation largely towards large caps and have minimal exposure to mid caps. You should check the asset allocation pattern of each fund and its investment strategy.
You can see that within Hybrid category, each sub-category comes with funds having varying degree of equity and debt exposure and consequently the risk profile of each category differs. One simple way to ascertain the degree of risk is through the scheme’s riskometer which spans from Low to Very High. A higher degree of risk means you need to invest for a longer time horizon and be prepared to face volatility.
Hybrid Funds can be ideal for investors who are investing in equity for the first time or do not want to take active decisions on their asset allocation themselves. Choose a fund which suits your risk profile, time horizon and goals.
Note: For fresh investments on or after 23 July 2024, schemes that invest at least 65% or more attract LTCG (12 month holding period) of 12.5% (exemption of up to 1.25 lakh) and STCG of 20%. Balanced Hybrid Funds attract LTCG (24 month holding period) of 12.5% while STCG is taxed at your slab rate.
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