How to Pick the Right Hybrid Fund?

As stock markets continue to fluctuate and predictions of higher volatilities do the rounds, most conservative and risk-averse investors are advised to turn to hybrid funds. This is because the equity-debt combination in hybrid funds is understood to maintain returns across different market cycles.

The right investment technique is to maintain a balanced portfolio with a mix of different risk levels that incorporate aggressive and conservative investment approaches in moderation. Investors who prefer to pick their own investments and who are unsure of where to invest or how much to invest must look for hybrid fund investments. These funds contain multiple asset classes within the same umbrella. 

However, within hybrid funds, there are six different categories. Each category has a unique risk level and performance potential. Therefore, not all hybrid funds will benefit all investors or investment time horizons. Here’s how one can pick the right hybrid fund for specific investment needs. Let’s first begin by understanding the meaning of hybrid funds.

What are hybrid funds?

Hybrid funds invest across different asset classes, like equity, debt, etc. There are different hybrid hybrid fund categories that adopt different asset allocation approaches. The asset allocation approach of one hybrid fund can be significantly different from another. Since the risk component of a fund depends on the asset allocation strategy, it can differ across hybrid funds categories. An investor must, therefore, very clearly understand the risk factor and make an informed investment decision. Since risk and returns are often related, the lesser the risk, the lower should be the returns expectations and vice versa.

What are the different types of hybrid mutual funds and which investor-type can invest in each?

Let’s have a look at the different types of hybrid funds and how each can suit different investment objectives and risk acceptance of investors. 

Conservative hybrid funds

These funds invest up to 25% in equity and the balance in fixed income instruments. These funds are especially structured for conservative investors who have a low-risk appetite. These can also benefit investors who want an additional source of income over their regular earnings. Since a very limited portion of the portfolio has exposure to equities, the high-risk levels posed by capital markets that typically come with equity investments are restricted in these funds. However, despite the low-risk levels, investors should avoid investing a lump sum in these funds to avoid any chances of loss occurring from market volatility.

Equity savings funds

Equity saving hybrid funds invest equally in stocks, instruments that are similar to FDs and risk-free hedging instruments.Thus, the overall equity exposure in these funds is partially hedged, which helps in reducing volatility. These funds offer better returns than bank Fixed Deposits of similar investment horizons. 

Multi asset allocation

Multi asset allocation hybrid funds invest a minimum of 10% in at least 3 different asset classes. These funds usually invest in a combination of equity, debt, and one other asset class such as gold, real estate, etc. The asset allocation strategy of these funds allow risk containment, however, lower allocation to stocks may result in lower returns. These are best suited for a 3 year investment horizon. 

Arbitrage funds

This fund aims to purchase stocks at comparatively lower rates as compared to prevailing market prices. The fund manager sells these stocks at a much higher price in a parallel market. However, there may not be many arbitrage opportunities existing at all times. Due to this, arbitrage funds tend to invest in cash or debt instruments. As is the case with most debt funds, these make for a safer investment option, however, the capital gains from these are taxable.

Aggressive hybrid

These hybrid funds are ideal for new investors who have a long investment horizon of 10 to 15 years. Investors who are in the accumulation phase can opt for these funds. It is best for investors to know the basics of equity mutual funds before they gradually switch to small cap, mid-cap and multi cap funds. These hybrid funds invest 65-80% of their assets into equities. 

Dynamic hybrid funds

Dynamic hybrid funds invest across various sectors including equity funds, real estate, stocks and bonds. In case of a market downturn during a recession or a bear economy, a dynamic hybrid fund can help in maintaining the risk threshold of investors. The in-build dynamic feature of these funds is their unique mechanism that helps to beat market slumps.

Additional read – Which is more beneficial – Equity or debt mutual fund

What are the important factors to consider while picking the right hybrid fund for investment?

Before investing in a hybrid fund, investors must know the following:

Risk-return assessment:

Before investing in a scheme, it is important to analyze its portfolio to gauge the risks involved. Knowing about the kind of stocks invested by the fund is a crucial aspect. For example, in an equity-oriented hybrid fund, check whether the fund’s majority investments are made in large-cap, small-cap or mid-caps to know the level of risks involved and the returns that can be expected.

Investment profile:

Check your personal risk appetite, investment horizon, and financial objectives before choosing a hybrid fund for investment.

Taxation:

In hybrid funds, returns from the equity investments are taxed in the same way as equity funds. Thus, Long-Term Capital Gains (LTCG) of over Rs. 1 lakh are taxed at 10% without indexation and Short-Term Capital Gains (STCG) are taxable at 15%. The debt investment returns of the hybrid fund are taxable like any other debt mutual fund. Capital gains from debt funds are added to the investor’s income and taxed as per the applicable income tax slab. LTCG tax from the debt component is taxable at 20% post indexation and 10% without indexation.

Conclusion

If you prefer to self-pick a fund for investment but want the convenience of a single scheme offering a well-diversified portfolio, hybrid funds are the answer for you. Since hybrid funds come in different varieties, it is important to know the type of fund that is best suited to your investment objective, risk appetite, financial goals, and investment time horizon. With the help of the factors mentioned above, you can select the right fund to maximise return from investment.

FAQs

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