Investments can be broadly classified into three types based on risk – equity (or high-risk) investments, debt (or low-risk) investments, and hybrid investments. Most investment advisors ask investors to create an investment plan based on their financial goals, risk tolerance, and investment horizon. Every individual has different needs and aspirations and hence it is difficult to classify an investor as a purely high-risk or low-risk-taker. This is where Hybrid Mutual Funds step in. here, we will explore Hybrid Funds and talk about some essential features that you need to know before investing in them.
As the name suggests, hybrid funds are a combination of equity and debt investments which are designed to meet the investment objective of the scheme. Each hybrid fund has a different combination of equity and debt targeted at different types of investors.
A hybrid fund endeavors to create a balanced portfolio to offer regular income to its investors along with capital appreciation in the long-term. The fund manager creates a portfolio according to the investment objective of the scheme and allocates the funds in equity and debt instruments in varying proportions. Further, the fund manager also buys or sells assets if the market movements are favorable.
Hybrid funds are considered to be riskier than debt funds but safer than equity funds. They tend to offer better returns than debt funds and are preferred by many low-risk investors. Further, new investors who are unsure about stepping into the equity markets tend to turn towards hybrid funds. This is because the debt component offers stability while they test the equity ‘waters’. Hybrid funds allow investors to make the most out of equity investments while cushioning themselves against extreme volatility in the market.
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Since every hybrid fund can have a different asset allocation between equity and debt, they can be classified into the following types:
Equity-oriented Hybrid Funds
An equity-oriented hybrid fund invests at least 65% of its total assets in equity and equity-related instruments of companies across various market capitalizations and sectors. The remaining 35% is invested in debt securities and money market instruments.
Debt-oriented Hybrid Funds
A debt-oriented hybrid fund invests at least 60% of its total assets in fixed-income securities like bonds, debentures, government securities, etc. The remaining 40% is invested in equity. Some funds also invest a small part of their corpus in liquid schemes.
These funds invest a minimum of 65% of their total assets in equity and equity-related instruments and the rest in debt securities and cash. For taxation, they are considered to be equity funds and offer tax exemption on long-term capital gains of up to Rs. 1 lakh. The fixed income component makes it a good option for equity investors as it helps mitigate the volatility of equity investments.
Monthly Income Plans
Monthly Income Plans are hybrid funds which primarily invest in fixed income securities and allocate a small portion of their corpus to equity and equity-related instruments. This allows these plans to generate better returns than pure debt schemes and allows the fund to offer regular income to investors. Most plans also offer a growth option where the income grows in the fund’s corpus.
Arbitrage funds buy stocks at a lower price in one market and sell it at a higher price in another. The fund manager constantly keeps looking for arbitrage opportunities and maximize the fund’s returns. However, there are times when good arbitrage opportunities are not available. During such times, the fund invests primarily in debt securities and cash. Arbitrage funds are considered to be as safe as debt funds. However, long-term capital gains are taxed like equity funds.
Here are some important aspects that you must consider before investing in hybrid funds in India:
The Risk-Return Assessment
Hybrid funds carry an investment risk proportionate to the allocation of assets in its portfolio. Hence, it is important to analyze the portfolio of the scheme carefully to get a good understanding of the risks involved. For example, if you are investing in an equity-oriented hybrid fund, then you must look at the kind of stocks the fund owns. Are the majorly large-caps or small/mid-caps? This helps you understand the risks better. Further, it will also give you an idea of the kind of returns that you can expect.
Choose the right Hybrid Fund
Since hybrid funds come in different types, it is important to consider your risk tolerance, financial goals, and investment horizon before choosing a scheme. If you need regular income, then opting for a debt-oriented hybrid fund might offer better returns than a pure debt fund due to the added equity component. Ensure that you consider these factors before investing.
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In hybrid funds, the tax on gains is as follows:
Equity component of the Hybrid Fund
This is taxed like equity funds:
Debt component of the Hybrid Fund
This is taxed like any pure debt fund. The capital gains are added to your income and taxed as per the applicable income tax slab.
Long-term capital gains from the debt component are taxed at 20% after indexation and 10% without indexation benefits.
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