What Is a Hybrid Fund?
A hybrid fund invests in both equity (stocks) and debt funds (bonds and fixed-income securities). The mix can vary depending on the type of hybrid fund selected, i.e., equity-oriented or debt-oriented. The idea is to balance risk and return. Some funds invest heavily in equities to offer higher returns with high risk, while others offer fixed returns with minimum risk.
For a better understanding, think of investing in hybrid funds as just like driving a car, the accelerator (equities) gives the speed to move ahead, while the brakes (debt) control the movement and ensure safety. Both are essential to reach your destination safely and right on time.
How Do Hybrid Funds Work?
Every hybrid fund follows a structured allocation model. Instead of putting all pooled money into one asset class, the fund manager divides it between equity and debt funds in proportions defined by the nature of the fund, i.e., is it equity-oriented or debt-oriented. If it's an equity-based scheme, the fund manager will majorly invest in equity, and only a small share is invested in debt funds and vice versa in the case of debt funds. The Securities and Exchange Board of India (SEBI) has defined allocation as per the category of hybrid funds to standardise the process throughout the industry. We shall discuss them later as we move forward to the types of hybrid funds.
Types of Hybrid Funds in India
The Securities and Exchange Board of India (SEBI) has classified hybrid funds into six sub-categories1
Conservative Hybrid Funds
With 75–90% invested in debt instruments and only 10–25% in equities and equity related instrument, these funds are for those who prioritise safety. The equity component offers a slight boost to returns compared to pure debt funds. These hybrid funds may be suitable for risk-averse investors who still want some market-linked growth.
Aggressive Hybrid Funds
These funds put 65–80% into equities and equity related instruments and the rest into debt instruments. They are suited for investors who have long-term investment goals and want higher returns but still wish to have some protection from market volatility.
Balanced Hybrid Funds
A Balanced Hybrid Fund, as defined by SEBI, invests 40–60% of its assets in equities and equity related instruments and 40–60% in debt instruments, offering a near-equal mix of growth potential and stability. Unlike other hybrid categories, no arbitrage is permitted in this fund. It is designed for investors seeking a balance between equity-driven upside and debt-based risk moderation, without leaning heavily toward either asset class.
Dynamic Asset Allocation Funds (Balanced Advantage Funds)
These funds adjust the mix of equity and debt funds based on market conditions. For instance, they may increase exposure to debt funds when markets are volatile and move towards equities when conditions look favourable for growth. Investors seeking a flexible allocation as per market conditions can benefit from this type of fund.
Multi-Asset Allocation Funds
These funds invest in a minimum of three asset classes, typically a mix of equity, debt, and commodities like gold with the minimum allocation in each asset class of 10%The idea is to diversify beyond just stocks and bonds, so even if one asset underperforms, others can balance the portfolio. This wider spread of investments helps reduce risk while offering steady returns.
Arbitrage Funds
An arbitrage fund invests a minimum of 65% in equity and equity-related instruments but uses hedging strategies in derivatives markets. This approach aims to provide relatively steady returns with relatively lower risk.
Equity Savings funds
These funds invest at least 65% in equity and equity-related instruments, and a minimum of 10% in debt. They also use derivatives to hedge, which helps manage risk and reduce volatility. The mix of equity, debt, and arbitrage makes them less risky than pure equity funds but slightly more rewarding than conservative hybrids. This mix aims to provide higher potential returns compared to balanced or conservative hybrid funds, but also comes with higher risk.
Benefits of Hybrid Funds
- Proper Balance Of Risk And Return -The mix of debt and equity in hybrid funds aims to balance return potential with market-associated risks.
- Diversification - A single fund provides exposure to multiple asset classes, reducing the need for investors to diversify separately.
- Flexibility Across Risk Profiles - With different types of hybrid funds, investors can choose options that match their risk appetite and investment objectives. This flexibility may make hybrid funds suitable for a wide range of investors.
- Professional Fund Management - Experts handle the asset allocation and rebalancing, saving investors from the hassle of constant monitoring.
- Systematic Investment and Withdrawals - Investors can enter hybrid funds through a Systematic Investment Plan (SIP) and later turn it into a Systematic Withdrawal Plan (SWP) to gradually redeem their corpus. This approach may support long-term wealth accumulation and structured withdrawals.
- Support for Long-Term Investment Goals – Hybrid funds can align well with Long-Term Investment Goals like buying a house, funding education, or retirement planning, however it is subjected to market risks.
Who Should Invest in Hybrid Funds?
Hybrid funds are suitable for investors across different stages of life, but the proportion of the debt-equity mix depends on the risk-taking capacity of investors. A person in their early 20s, just starting their career, might be comfortable with a higher allocation to equities since they are young and don't have many responsibilities on their shoulders, and they may have a higher capacity to withstand market volatility.
At the same time, someone in their 40s, juggling responsibilities like home loans or children’s education, may lean toward a balanced or dynamic hybrid that offers growth but also protects against market swings.
Retirees, on the other hand, often prefer conservative funds that provide stability and periodic income while still keeping a portion invested in equities for inflation-adjusted returns.
Things to Consider Before Investing in Hybrid Funds
- Debt–Equity Mix - Each type of hybrid fund has a different allocation in equity and debt. Understanding the mix is important because it directly affects potential returns and risk.
- Risk and Returns – Hybrid funds offer different options as per different risk profiles and investment objectives. Aggressive funds may provide higher growth but are also highly volatile, while debt-oriented funds tend to be steadier with moderate returns.
- Investment Horizon - The time you plan to stay invested can influence your fund selection. Longer horizons allow investors to ride out short-term market fluctuations, especially in equity-oriented or aggressive hybrids.
- Past Performance - Past performance provides insight into how the fund has handled market volatility, though it’s not a guarantee of future returns.
- Expense Ratio - Expense ratio is the annual fee charged by the fund for managing investments. Lower expense ratios allow investors to retain more of the fund’s returns, making it an important factor to compare.
- Liquidity - Hybrid funds generally allow easy entry and exit, but some investment options may have lock-in periods or exit loads. So it’s important to check these details before investing to ensure liquidity and easy access to funds.
- Taxation - Tax treatment varies based on equity and debt fund allocation. If a fund invests more than 65% in equities, they are considered an equity hybrid fund and enjoys equity taxation benefits, while debt-heavy hybrids follow debt taxation rules.
Key Takeaways
- Hybrid funds mix equity and debt to offer growth potential with moderated risk.
- A variety of options, from conservative to aggressive, cater to a wide range of investors as per their risk appetite and investment objectives.
- Professional managers oversee asset allocation and rebalancing, ensuring strategic portfolio management.
- Diversification across various asset classes may reduce exposure to risk.
- Factors such as debt equity mix, fund ratings, expense ratio, past performance, etc., should be studied before investing.
Conclusion
Hybrid funds bring together equities and debt funds under one umbrella, allowing a single product to capture both high growth potential and risk minimisation. This way, investors may benefit from exposure to both equities and debt, helping to balance growth potential and risk
Read all scheme-related documents and get a thorough understanding of crucial terms like asset allocation strategy, fund ratings, expense ratio, etc. and make a well-informed decision.
Frequently Asked Questions
Are hybrid funds safe for first-time investors?
Hybrid funds may be relatively less volatile compared to pure equity funds, but they are market-linked and carry risks. These funds are diversified largely between across equity and debt securities.
Can hybrid funds provide a monthly income?
Some hybrid funds offer dividend payout options that can provide regular income. It is advisable to check before investing.
What is the difference between hybrid and balanced funds?
Balanced funds are a type of hybrid fund only, but with a fixed equity-debt allocation, usually in a ratio of 40:60 in either debt or equity. Other Hybrid funds, like have a different allocation to equity and debt securities as defined as per SEBI.
Are hybrid funds better than pure equity funds?
Hybrid funds and pure equity funds serve different purposes. While hybrid funds balance returns and safety by mixing equity and debt funds, pure equity funds focus entirely on equity, which might give higher returns depending on market conditions in the long-term but pure equity funds historically has shown highly volatile too.
How long should I stay invested in a hybrid fund?
The investment tenure depends on your financial goals and needs. However, it is recommended to choose a medium to long-term investment horizon to ride out market volatility and to help manage volatility and potentially benefit from long-term growth..
Are hybrid funds taxable in India?
Yes, hybrid funds are taxable in India. The tax treatment depends on their equity–debt allocation. If a hybrid fund invests at least 65% in equities, it is taxed like an equity fund. If it invests a minimum of 65% in debt, it is treated like debt funds for taxation purposes.
Sources:
- https://www.sebi.gov.in/legal/circulars/oct-2017/categorization-and-rationalization-of-mutual-fund-schemes_36199.html
