Hybrid Funds Guide – Meaning, Types & How to Invest in 2022
Hybrid funds provide the best of both worlds
On the one hand, while equity funds have the potential to provide high inflation-beating returns, they carry high risk. On the other hand, debt funds carry low risk but can provide only low to moderate returns. But, hybrid funds can provide you with the best of both worlds. In this article, we will understand the meaning of hybrid funds, their types, and how to invest in them.
What are hybrid funds?
A hybrid fund provides an investor exposure to multiple asset classes through a single mutual fund scheme. Most hybrid funds provide investors exposure to two asset classes: equity and debt. The proportion of equity and debt will depend on the category of the hybrid some. Hybrid funds also include multi-asset allocation funds that provide investors exposure to three asset classes.
How does a hybrid fund work?
A hybrid fund collects money from investors and invests them in multiple asset classes such as equity, debt, real estate, commodities, etc., based on the fund's objective. The investors are allotted units in proportion to their investment in the scheme.
- In the case of some hybrid funds, the fund manager manages the proportion/rebalancing of equity and debt at their discretion.
- In the case of some hybrid funds, the ratio of debt to equity is fixed based on some parameters.
- In the case of some hybrid funds, the ratio of equity and debt is managed dynamically.
For example, the equity/debt ratio of a hybrid fund starts at, say, 60:40. Assume the equity market sees a sharp rally, and due to this, the equity/debt ratio goes to 75:25. In this case, if the fund manager feels that equity markets are overvalued, they will sell some equity shares and book profits. The profits will be invested in debt securities, and the equity/debt ratio will again be rebalanced to the original 60:40 ratio. As the NAV of the unit goes up, the unitholders benefit, and as the NAV of the unit goes down, the unitholders suffer losses.
Who should invest in a hybrid mutual fund?
An investor who doesn't want to invest separately in an equity and debt mutual fund may invest in a hybrid mutual fund. The equity component gives the investor's portfolio a boost when equity markets are doing well. Similarly, when the equity market is down, the debt portfolio lends stability to the investor's portfolio. Thus, with a hybrid fund, an investor enjoys the benefits of equity and debt in a single scheme.
Types of hybrid funds
SEBI has categorised hybrid funds in seven sub-categories as follows.
|Type of hybrid fund||Scheme characteristics|
|Conservative hybrid fund||An open ended scheme that predominantly invests 75-90% of its total assets in debt instruments and 10-25% of its total assets in equity and equity related instruments.|
|Balanced hybrid fund||An open ended scheme that invests 40-60% of its total assets in equity and equity related instruments and 40-60% of its total assets in debt instruments. The fund manager decides the proportion of equity and debt instruments and their rebalancing.|
|Aggressive hybrid fund||An open ended scheme that predominantly invests 65-80% of its total assets in equity instruments and 20-35% of its total assets in debt instruments.|
|Dynamic asset allocation or balanced advantage fund||An open ended scheme that invests in a mix of equity and debt instruments wherein the proportion is managed dynamically|
|Multi asset allocation fund||An open ended scheme that invests in at least three asset classes. The minimum allocation is at least 10% in each of the three asset classes.|
|Arbitrage fund||An open ended scheme that follows an arbitrage strategy and invests a minimum of 65% of its total assets in equity and equity related instruments.|
|Equity savings fund||An open ended scheme that invests a minimum of 65% of its total assets in equity and equity related instruments and a minimum of 10% of its total assets in debt instruments.|
Mutual fund houses are permitted to offer either an aggressive hybrid fund or a balanced fund to their investors.
Factors to consider before investing in hybrid mutual funds
An investor should consider various factors before investing in hybrid mutual funds, some of which include:
- Asset mix: An investor should consider whether they want to invest in a mix of two or three different asset classes and also the proportion of each asset class.
- Investment time horizon: If an investor is looking for equity exposure (40% or higher) through a hybrid fund, the investment time horizon should be at least five years or more. If the equity exposure is in the 10-40% range, the investment time horizon should be at least three years to enjoy overall favourable tax treatment.
- Age: A young investor in the age group of 25-30 years may choose an aggressive hybrid fund, a mid-age investor in the age group of 35-45 years may choose a balanced hybrid fund, and an investor in the age group of 50-55 years may choose a conservative hybrid fund.
- Returns: If an investor has a conservative risk profile and expects low to moderate returns, they may choose a hybrid fund with up to 40% equity exposure. If an investor has an aggressive risk profile and expects high returns, they may choose a hybrid fund with an equity exposure of 40% or higher.
Advantages of Hybrid funds
Hybrid funds maintain a balance between the risk you take and the returns that you expect. They reduce the high risk that comes from equity with the low risk of debt. They boost the low returns of debt with high returns of equity. Thus, hybrid funds provide much-needed balance to your overall investment portfolio.
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