In mutual funds, asset classes refers to categories of instruments which are grouped together based on their risk / return characteristics. The most common asset classes are equity, debt, gold and real estate; Asset allocation refers to the mix of asset classes (% equity, % debt etc) in your investment portfolio. Asset allocation balances risks / returns and help you achieve your financial goals. Hybrid funds are mutual fund schemes which invest in multiple asset classes e.g. equity, fixed income, gold etc. These schemes provide investors exposure to multiple asset classes and asset allocation benefits thereof.
The most common asset allocation strategies involve equity and debt asset classes. Hybrid mutual funds are designed for investors seeking a risk profile between a pure equity portfolio or pure debt portfolio, offering the growth potential of equities along with the safety of fixed-income securities. However, hybrid funds can provide you exposure to other asset classes also like gold, real estate etc. Various types of hybrid funds cater to different risk appetites. Depending on their equity allocation, the tax treatment of hybrid funds can vary from scheme to scheme.
Hybrid mutual funds have been around in India for many years now. Among extant hybrid funds, the oldest vintage is 25 – 30 years. As per AMFI July data, total assets under management (AUM) in hybrid funds is around Rs 5.5 lakh crores which is around 12% of mutual fund industry’s open ended schemes AUM (source: AMFI, 31st July 2023). Hybrid mutual funds are popular among investors who do not have high risk appetites. Some hybrid funds also give regular dividends / IDCW; as such, they are also popular with investors who need regular cash-flows.
Frequently asked questions
What are Hybrid Mutual Funds?
Hybrid mutual funds are unique financial instruments because they invest in multiple asset classes. Often, these funds invest in both Equity and Debt. Sometimes, they expand their portfolio to include assets like Gold or Real Estate. The core philosophy driving hybrid funds rests onasset allocation. Different hybrid funds have different asset allocation strategies, catering to different risk appetites and investment needs.
Significant evidence presented by scholars and industry practitioners suggests that combining asset classes with relatively low or negative correlation of returns can effectively reduce a portfolio's overall risk and provide stability of returns. This is where hybrid mutual funds shine. They diversify investments across several asset classes to secure returns while minimising associated risks.
SEBI has asset allocation mandates for different categories of hybrid funds, however, fund managers also have considerable flexibility in deciding allocation to each asset class within the SEBI mandates. The asset allocation strategies are guided by the specific investment objectives of the fund and the prevailing market conditions.
Hybrid mutual funds are unique financial instruments because they invest in multiple asset classes. Often, these funds invest in both Equity and Debt. Sometimes, they expand their portfolio to include assets like Gold or Real Estate. The core philosophy driving hybrid funds rests onasset allocation. Different hybrid funds have different asset allocation strategies, catering to different risk appetites and investment needs. Significant evidence presented by scholars and industry practitioners suggests that combining asset classes with relatively low or negative correlation of returns can effectively reduce a portfolio's overall risk and provide stability of returns. This is where hybrid mutual funds shine. They diversify investments across several asset classes to secure returns while minimising associated risks. SEBI has asset allocation mandates for different categories of hybrid funds, however, fund managers also have considerable flexibility in deciding allocation to each asset class within the SEBI mandates. The asset allocation strategies are guided by the specific investment objectives of the fund and the prevailing market conditions.
How Does a Hybrid Fund Work?
Hybrid funds have twin investment objectives:
- Capital Appreciation - Through equity portion of the portfolio, these funds aim for capital appreciation over long investment horizon.
- Income – The debt portion of the portfolio of hybrid funds generate income and provide stability.
Depending on the mandate of the hybrid scheme, some hybrid funds will tilt towards capital appreciation, and some will focus on income and stability of returns. This will be captured in the Scheme Information Document (SID) under ‘Asset Allocation’. When making asset allocation decisions, hybrid fund managers always keep these objectives at the forefront. They diligently assess the market, ensuring the right asset allocation in equity, debt and other asset classes.
Types of Hybrid Funds
SEBI has classified Hybrid funds into 7 sub-categories as follows. Among these,SEBI has allowed an AMC to launch only one of the two – a Balanced Fund and / or an Aggressive Hybrid Fund,
Conservative Hybrid Fund
10% to 25% in equity & equity-related instruments, rest in debt instruments.
Balanced Hybrid Fund
40% to 60% in equity & equity-related instruments, rest in debt instruments.
Aggressive Hybrid Fund
65% to 80% in equity & equity-related instruments, rest in debt instruments.
Dynamic Asset Allocation or Balanced Advantage Fund
Allocation between equity/debt is managed dynamically (0% to 100%) in equity & debt instruments.
Multi-Asset Allocation Fund
Investment in at least 3 asset classes with a minimum allocation of at least 10% in each asset class.
Equity Savings
Equity and equity-related instruments (min.65%); debt instruments (min.10%) and derivatives (used for hedging & it is to be specified in the SID).
Arbitrage Fund
Scheme following arbitrage strategy, with a minimum 65% investment in equity & equity-related instruments.
Hybrid funds have twin investment objectives:
- Capital Appreciation - Through equity portion of the portfolio, these funds aim for capital appreciation over long investment horizon.
- Income – The debt portion of the portfolio of hybrid funds generate income and provide stability.
Depending on the mandate of the hybrid scheme, some hybrid funds will tilt towards capital appreciation, and some will focus on income and stability of returns. This will be captured in the Scheme Information Document (SID) under ‘Asset Allocation’. When making asset allocation decisions, hybrid fund managers always keep these objectives at the forefront. They diligently assess the market, ensuring the right asset allocation in equity, debt and other asset classes.
Types of Hybrid Funds
SEBI has classified Hybrid funds into 7 sub-categories as follows. Among these,SEBI has allowed an AMC to launch only one of the two – a Balanced Fund and / or an Aggressive Hybrid Fund,
| Conservative Hybrid Fund | 10% to 25% in equity & equity-related instruments, rest in debt instruments. |
| Balanced Hybrid Fund | 40% to 60% in equity & equity-related instruments, rest in debt instruments. |
| Aggressive Hybrid Fund | 65% to 80% in equity & equity-related instruments, rest in debt instruments. |
| Dynamic Asset Allocation or Balanced Advantage Fund | Allocation between equity/debt is managed dynamically (0% to 100%) in equity & debt instruments. |
| Multi-Asset Allocation Fund | Investment in at least 3 asset classes with a minimum allocation of at least 10% in each asset class. |
| Equity Savings | Equity and equity-related instruments (min.65%); debt instruments (min.10%) and derivatives (used for hedging & it is to be specified in the SID). |
| Arbitrage Fund | Scheme following arbitrage strategy, with a minimum 65% investment in equity & equity-related instruments. |
What are the benefits of Hybrid Funds?
- Hybrid mutual funds offer asset allocation benefits whereby investors can balance risk and return to achieve their financial goals. The equity allocation of hybrid funds can generate higher potential returns in the long term while the debt allocation reduces volatility and provides stability.
- Hybrid funds provide the benefit of periodic portfolio rebalancing. Rebalancing of assets ensures that the asset allocation of your investments do not deviate from the targeted asset allocation despite market movements. Portfolio rebalancing is aimed to reduce risk and help in generating relatively better risk adjusted returns over sufficiently long investment tenures. Please note that different funds follow different rebalancing strategies. You should read the scheme information document before investing.
- Since hybrid funds are less volatile compared to pure equity funds, they are suitable for first time or new investors looking for the long term but who do not have experience of high market volatility.
- Hybrid funds which have 65% gross equity allocation (including hedging) enjoy equity taxation. We will discuss taxation of hybrid mutual funds in the last section.
Factors to consider when investing in Hybrid Mutual Funds
- Setting Clear Investment Goals: It is important to outline what you are aiming for with your investments i.e. your financial goals. Are you leaning towards growth or income? If you are looking for growth or capital appreciation, you may want to consider aggressive hybrid funds. However, bear in mind with growth come higher risks. Conservative hybrid funds might be a more suitable option if you prefer a lower volatility / portfolio stability. Arbitrage funds may be suitable for parking your idle funds with low capital risks. Clarify what you are saving for e.g. retirement nest egg, your children's education, unforeseen medical expenses, or an emergency fund for unexpected events and make informed investment decisions. There fiore, selecting the best hybrid funds should be based on your investment goals and your risk appetite.
- Determining Your Investment Horizon: The time you plan to remain investedshould be directly liked to your investment goals. Aggressive hybridor multi asset hybrid funds might be the way to go for long-term investments, such as retirement planning. Long investment horizons give you sufficient time to navigate the market's highs and lows. If your goals are mid to long term, balanced advantage or equity savings funds, offering a blend of growth and income, may be suitable. For short to medium term objectives, conservative hybrid funds can be suitable investment options.
- Assessing Your Comfort with Risk: Before plunging into the world of mutual funds, it is important to understand your risk appetite. Different hybrid funds have different risk profiles depending on their asset allocation. Make sure that the risk profile of your fund is aligned with your risk appetite. Therefore, for an investor the best hybrid funds are the ones which suit their risk appetite and investment time horizon.
- Current market valuations: Making asset allocation decisions based on current market valuations can reduce downside risk to your portfolio and create the potential of getting superior risk adjusted returns. For example, when markets are at highs, it may be prudent to invest in hybrid funds as opposed to pure equity funds. You may invest in aggressive hybrid, balanced advantage, multi asset or equity savings funds based on your own risk appetite. Similarly when markets are its lows, you can think of allocating more of your investments in equity funds so that you can take advantage of attractive valuations and generate superior risk adjusted returns for your portfolio over sufficiently long investment horizons.
- Hybrid mutual funds offer asset allocation benefits whereby investors can balance risk and return to achieve their financial goals. The equity allocation of hybrid funds can generate higher potential returns in the long term while the debt allocation reduces volatility and provides stability.
- Hybrid funds provide the benefit of periodic portfolio rebalancing. Rebalancing of assets ensures that the asset allocation of your investments do not deviate from the targeted asset allocation despite market movements. Portfolio rebalancing is aimed to reduce risk and help in generating relatively better risk adjusted returns over sufficiently long investment tenures. Please note that different funds follow different rebalancing strategies. You should read the scheme information document before investing.
- Since hybrid funds are less volatile compared to pure equity funds, they are suitable for first time or new investors looking for the long term but who do not have experience of high market volatility.
- Hybrid funds which have 65% gross equity allocation (including hedging) enjoy equity taxation. We will discuss taxation of hybrid mutual funds in the last section.
Factors to consider when investing in Hybrid Mutual Funds
- Setting Clear Investment Goals: It is important to outline what you are aiming for with your investments i.e. your financial goals. Are you leaning towards growth or income? If you are looking for growth or capital appreciation, you may want to consider aggressive hybrid funds. However, bear in mind with growth come higher risks. Conservative hybrid funds might be a more suitable option if you prefer a lower volatility / portfolio stability. Arbitrage funds may be suitable for parking your idle funds with low capital risks. Clarify what you are saving for e.g. retirement nest egg, your children's education, unforeseen medical expenses, or an emergency fund for unexpected events and make informed investment decisions. There fiore, selecting the best hybrid funds should be based on your investment goals and your risk appetite.
- Determining Your Investment Horizon: The time you plan to remain investedshould be directly liked to your investment goals. Aggressive hybridor multi asset hybrid funds might be the way to go for long-term investments, such as retirement planning. Long investment horizons give you sufficient time to navigate the market's highs and lows. If your goals are mid to long term, balanced advantage or equity savings funds, offering a blend of growth and income, may be suitable. For short to medium term objectives, conservative hybrid funds can be suitable investment options.
- Assessing Your Comfort with Risk: Before plunging into the world of mutual funds, it is important to understand your risk appetite. Different hybrid funds have different risk profiles depending on their asset allocation. Make sure that the risk profile of your fund is aligned with your risk appetite. Therefore, for an investor the best hybrid funds are the ones which suit their risk appetite and investment time horizon.
- Current market valuations: Making asset allocation decisions based on current market valuations can reduce downside risk to your portfolio and create the potential of getting superior risk adjusted returns. For example, when markets are at highs, it may be prudent to invest in hybrid funds as opposed to pure equity funds. You may invest in aggressive hybrid, balanced advantage, multi asset or equity savings funds based on your own risk appetite. Similarly when markets are its lows, you can think of allocating more of your investments in equity funds so that you can take advantage of attractive valuations and generate superior risk adjusted returns for your portfolio over sufficiently long investment horizons.
Who Should Invest in a Hybrid Mutual Fund?
- Hybrid funds can provide investment solutions for a wide variety of investment tenures from a few months to many years and risk appetites from low to moderately high.
- You should select the best hybrid funds based on your risk appetite and specific investment needs. You should consult with your financial advisor or mutual fund distributor if you need help in understanding your risk appetite and the risk profile of different hybrid funds.
- Hybrid funds can provide both capital appreciation and income. Aggressive hybrid mutual funds are primarily oriented towards capital appreciation, while conservative hybrid funds are oriented towards income, even though they can also provide capital appreciation over long investment tenures. Investors looking for both capital appreciation and income can also invest in hybrid funds.
- Hybrid funds can be efficient asset allocation solutions for investors who want to get exposure to multiple asset classes. Aggressive hybrid, balanced advantage and equity savings funds provide exposure to debt and equity, while multi-asset allocation funds provide exposure to three or more asset classes.
- Hybrid funds provide tax efficient investment solutions for investors who want to enjoy equity taxation and at the same time reduce portfolio risk. Equity oriented hybrid scheme enjoy equity taxation by keeping the debt allocation below 35%. Some hybrid funds take less than 65% net exposure in equity through hedging and still enjoy equity taxation through hedging / arbitrage.
Tax Implications on Hybrid Mutual Funds
The taxation of hybrid funds will depend upon its average monthly equity allocation over the last 12 months.
Percentage of Equity Exposure
Taxation
0% to 35%
Capital gains irrespective of holding period will be added to your income and taxed as per your income tax slab.
36% to 64%
Capital gains for holding period of less than 3 years will be added to your income and taxed as per your income tax slab. Capital gains for holding period of more than 3 years will be taxed at 20% after allowing for indexation benefits.
65% or more
Capital gains for holding period of less than 12 months (short term capital gains) will be taxed at 15%. Capital gains for holding period of more than 12 months will be tax free up to Rs 1 lakh and taxed at 10% thereafter.
Income distribution cum capital withdrawal (IDCW) or dividends paid by hybrid funds will be added to your income and taxed as per your income tax slab. Consult with your financial advisor or mutual fund distributor to understand the tax implications of hybrid mutual funds so that you can choose the best hybrid mutual fund for your investments.
- Hybrid funds can provide investment solutions for a wide variety of investment tenures from a few months to many years and risk appetites from low to moderately high.
- You should select the best hybrid funds based on your risk appetite and specific investment needs. You should consult with your financial advisor or mutual fund distributor if you need help in understanding your risk appetite and the risk profile of different hybrid funds.
- Hybrid funds can provide both capital appreciation and income. Aggressive hybrid mutual funds are primarily oriented towards capital appreciation, while conservative hybrid funds are oriented towards income, even though they can also provide capital appreciation over long investment tenures. Investors looking for both capital appreciation and income can also invest in hybrid funds.
- Hybrid funds can be efficient asset allocation solutions for investors who want to get exposure to multiple asset classes. Aggressive hybrid, balanced advantage and equity savings funds provide exposure to debt and equity, while multi-asset allocation funds provide exposure to three or more asset classes.
- Hybrid funds provide tax efficient investment solutions for investors who want to enjoy equity taxation and at the same time reduce portfolio risk. Equity oriented hybrid scheme enjoy equity taxation by keeping the debt allocation below 35%. Some hybrid funds take less than 65% net exposure in equity through hedging and still enjoy equity taxation through hedging / arbitrage.
Tax Implications on Hybrid Mutual Funds
The taxation of hybrid funds will depend upon its average monthly equity allocation over the last 12 months.
| Percentage of Equity Exposure | Taxation |
|---|---|
| 0% to 35% | Capital gains irrespective of holding period will be added to your income and taxed as per your income tax slab. |
| 36% to 64% | Capital gains for holding period of less than 3 years will be added to your income and taxed as per your income tax slab. Capital gains for holding period of more than 3 years will be taxed at 20% after allowing for indexation benefits. |
| 65% or more | Capital gains for holding period of less than 12 months (short term capital gains) will be taxed at 15%. Capital gains for holding period of more than 12 months will be tax free up to Rs 1 lakh and taxed at 10% thereafter. |
Income distribution cum capital withdrawal (IDCW) or dividends paid by hybrid funds will be added to your income and taxed as per your income tax slab. Consult with your financial advisor or mutual fund distributor to understand the tax implications of hybrid mutual funds so that you can choose the best hybrid mutual fund for your investments.
