Updated: Mar 29, 2021
Hybrid Funds - Successful investing is about managing risk, not avoiding it”, said Benjamin Graham, a British-born American investor who was known for his theories on investment. His quote has become a mantra for several Indian millennials who seek exciting investment opportunities in lieu of textbook options.
Experts explain that the herd mentality’ in investment, where children follow the path shown by parents, has witnessed a sharp reduction. It indicates that young investors are now looking for diverse options rather than opting for traditional fixed deposit or tax-saving post office schemes.
And thus one such option are HYBRID FUNDS
What are Hybrid Funds?
Hybrid funds invest in both debt and equity instruments to achieve diversification and avoid the concentration risk. A perfect blend of the two offers higher returns than a regular debt fund while not being as risky as equity funds. The choice of a hybrid fund depends on your risk preferences and investment objective.
How Does it Work?
Hybrid funds aim to achieve wealth appreciation in the long-run and generate income in the short-run via a balanced portfolio. The fund manager allocates your money in varying proportions in equity and debt based on the investment objective of the fund. The fund manager may buy/sell securities to take advantage of market movements.
Who Should Invest in Hybrid Funds?
Hybrid funds are considered a safer bet than equity funds. These provide higher returns than genuine debt funds and are popular among conservative investors. Budding investors (like us) who are willing to get exposure to equity markets may invest in hybrid funds. The presence of equity components in the portfolio offers the potential to earn higher returns.
At the same time, the debt component of the fund provides a cushion against extreme market fluctuations. In this way, you receive stable returns instead of a total burnout that may happen in case of pure equity funds. For the less conservative category of investors, the dynamic asset allocation feature of some hybrid funds becomes a great way to enjoy the best out of market fluctuations.
Things an Investor Should Consider
a. Risk factor
It would not be wise to assume hybrid funds to be completely risk-free. Any instrument which invests in equity markets will have some risk. It might be less risky than pure equity funds, but you need to exercise caution and portfolio rebalancing regularly.
They don’t offer guaranteed returns. The performance of underlying securities affects the Net Asset Value (NAV) of these funds. So, it may fluctuate due to market movements. Moreover, these might not declare dividends during market downturns.
They would charge a fee for managing your portfolio, which is known as the expense ratio. Before investing in a hybrid fund, ensure it has a low expense ratio than other competing funds, and this translates into higher take-home returns for the investor.
d. Investment Horizon
Hybrid funds may be ideal for a medium-term investment horizon, say five years. If you want to earn a risk-free rate of return, you may go for arbitrage funds. They bet on price differentials of securities in different markets.
e. Financial Goals
You can meet intermediate financial goals like buying a car or funding higher education with hybrid funds. Retirees too invest in balanced funds and go for a dividend option to supplement their post-retirement income.
f. Tax on Gains
The equity component of hybrid funds is taxed like equity funds. Long-term capital gains over Rs.1 lakh on equity component are taxed at the rate of 10%. Short-term capital gains (STCG) on equity component are taxed at the rate of 15%.
The debt component of hybrid funds is taxable as any other debt fund. You must add these gains to your income and taxed as per your income slab. LTCG from debt component is taxable at 20% after indexation and 10% without the benefit of indexation
While selecting a fund, you need to analyse the fund from various perspectives. Various quantitative and qualitative parameters can tell you which is the best hybrid fund that suits you. Additionally, you need to keep your financial goals, risk appetite, and investment horizon in mind.