What are Hybrid Mutual Funds?

Hybrid funds are a type of mutual fund that invests in two or more asset classes, typically including both debt and equity. The guiding principles for these funds are diversification and asset allocation to balance risk and return. There are various types of hybrid funds, depending on the allocation between asset classes and the fund's objectives.

Every individual has different needs, aspirations, and financial objectives, so it is difficult to classify an investor as purely a high-risk-taker or a low-risk-taker. This is where Hybrid Mutual Funds step in. Depending on the portion of investment in different asset classes and the schemes objective, hybrid funds are of various types. And among these various types, you can find the schemes that suit you best.

In this article, we will discuss what hybrid funds mean, the different types of hybrid funds, their benefits and factors for you to consider before choosing a scheme to invest.

What are Hybrid Mutual Funds and How do they Work？

Hybrid mutual funds essentially try to offer the best of multiple asset classes in a single product. The equity portion generates returns when the stock market is performing well, while the debt portion provides stability. These funds seek to achieve long-term capital growth through equity and short-term stability & regular income through debt. They act as a good entry point for new investors in the equity market.

Equity investments have the potential for high returns but come with short-term volatility and greater risk. Debt investments, on the other hand, provide regular income and stability with lower risk compared to stocks. These two asset classes, equity and debt, have a low correlation, and combining them in hybrid funds helps reduce overall portfolio risk.

Equity and debt share a low correlation, which is why hybrid funds tend to perform well when pure equity funds struggle in a bear market. Equity stocks and debt instruments generally move in opposite directions. This is because when the stock market grows, investors move money from debt to equity, boosting stock values. Conversely, during an equity market turmoil, investors shift to debt to protect their capital while still earning stable returns.

In summary, hybrid mutual funds offer a balanced approach to investing by combining different asset classes, making them suitable for investors with varying risk profiles and financial goals. They enable investors to benefit from diversification and asset allocation, ultimately helping them tailor their investments to their specific needs and aspirations.

Types of Hybrid Mutual Funds

As per the Securities and Exchange Board of India (SEBI), there are 7 sub-categories/types of Hybrid Mutual Funds. Each sub-category is differentiated based on varying equity and debt allocation.

• Conservative Hybrid Fund: 10% to 25% investment in equity & equity-related instruments; and 75% to 90% in Debt instruments.

The Debt asset class includes fixed income-generating securities such as treasury bills, corporate bonds, commercial papers, certificate of deposits and others.

• Balanced Hybrid Fund: 40% to 60% investment in equity & equity related instruments; and 40% to 60% in Debt instruments.

Investors who are looking for long-term capital generation can opt for a balanced Hybrid Fund, as the Debt financial instruments help to offset the risks posed by the Equity asset class.

• Aggressive Hybrid Fund: Aggressive Hybrid Fund: 65% to 80% investment in equity & equity related instruments; and 20% to 35% in Debt instruments.

Here, there is a possibility to earn higher returns at a reduced risk due to the allocation of Debt Securities in the portfolio.

• Dynamic Asset Allocation/Balanced Advantage Fund: This type of Hybrid Fund is suitable for investors who want to automate asset allocation. These funds are dynamic in nature, which means you have the flexibility to shift 100% to Debt financial instruments or 100% to the Equity asset class. The asset allocation is decided based on the recommendation of the financial model of the fund. These schemes adjust its equity and debt allocation as per the market conditions. The very aim of balanced advantage funds is to take “advantage” of higher returns that equities offer while maintaining the “balance” on risk by investing in debt when equities prices are not too advantageous. They adopt buy low sell high technique.

• Multi-Asset Allocation Fund: Investment in at least 3 asset classes with a minimum allocation of at least 10% in each asset class.

• Arbitrage Hybrid Fund: This Mutual Fund scheme follows an arbitrage strategy with a minimum of 65% investment in Equity and Equity-related instruments. These schemes offer returns comparable to liquid or overnight funds but with equity taxation.

• Equity Savings Fund: This is an open-ended scheme that invests in Equity, Arbitrage and Debt Securities. The minimum investment in Equity and Equity-related instruments should be 65% of the total assets and the minimum investment in Debt should be 10% of the total assets. The minimum hedged and unhedged investment needs to be stated in the Scheme Information Document (SID). Asset Allocation under defensive considerations may also be stated in the Offer Document.

Benefits of Hybrid Mutual Funds

Hybrid mutual funds provide a unique advantage by allowing investors to access multiple asset categories through a single fund, eliminating the need for multiple separate investments.

• Capital appreciation: Equity portion in the scheme portfolio can help you grow your wealth in medium to long term.

• Low Volatility: The overall volatility of the entire portfolio is reduced as compared to pure equity schemes because of the debt allocation of the fund.

• Diversification: This is a crucial benefit of hybrid mutual funds, as they diversify not only across different asset classes but also across sub-classes within each class, such as large-cap, mid-cap, small-cap stocks, and value or growth stocks, enhancing portfolio diversification.

• Active rebalancing: Active rebalancing is a key feature of hybrid mutual funds, where fund managers adjust the portfolio in response to evolving market conditions to optimise returns for investors. These funds prioritise active risk management by strategically diversifying and allocating assets across non-correlated classes such as equity and debt, to effectively mitigate risks.

• Caters to various risk profiles: Hybrid mutual funds offer choices for different risk preferences. They have options for conservative, moderate, and aggressive investors. There are equity-oriented schemes for the risk-taker and debt-oriented schemes for the risk-averse. Dynamic asset allocation funds are for those who want flexibility in adjusting their investments based on market conditions without making the decisions themselves.

Factors to consider in Hybrid Mutual Fund Selection

As is the case with any other mutual fund investment, it is important to consider your risk tolerance, expected returns, financial goals, and investment horizon before choosing a scheme.

Ensure that you consider these factors before making the investment decision.

• Returns: Hybrid funds are composed of both equity and debt, in some cases, even more asset types. Their results are affected by the performance of the underlying assets, so theres no guarantee of consistent returns. Different types of hybrid funds – with their varying asset class compositions – offer different management and portfolio strategies. As an investor, you should go through and understand all the different types of hybrid mutual funds and what they have to offer, then pick the ones that align the most closely with your investment goal, preferences and risk appetite.

• Risk: The risk level depends on the proportion of asset allocation of each category. For example, in the case there is more equity holding in the portfolio, that means the overall returns will be majorly influenced by the equitys performance. The higher the equity portion, the riskier the fund. In case the funds are more debt-oriented, risk will be defined by the motive behind debt allocation – whether it is for interest income or capital gains. A fund that gets its return mainly from interest income of debt securities may be less risky than a fund that depends on gains from price appreciation.

• Time Horizon: Hybrid fund investments are mainly suited for a medium-term time horizon of at least 3+ years. Nevertheless, the various types of hybrid funds provide different options to the investors, so they can choose the kind of hybrid fund that caters to their preferred investment time horizon. Being comprised of both equity and debt instruments, you won't have to worry about choosing between creating wealth in the long term and getting regular income in the short term.

• Investment Strategy: Hybrid funds are also known as asset allocation funds. Since hybrid mutual funds come in different types, there certainly exists one to suit every type of investor. Whether you want regular income, risk mitigation, or capital appreciation, it is important to not only be fully aware of your investment goals but also to note if the combination of assets selected and the proportions in each asset will help you reach those goals.

Conclusion

To sum it up, think of hybrid funds as the best of both worlds – a mix of equity and debt; a fund that provides a versatile and balanced investment option. Whether you're cautious or adventurous, hybrid funds can be your go-to choice. By understanding these funds and how they work, you can align your financial goals to meet your needs. These funds offer investors a diversified portfolio, reducing risk while providing opportunities for growth. So, explore the world of hybrid funds, diversify your investments, and pave the way for a more secure financial future.