How to choose hybrid funds
If you are having a low to medium risk profile and want to take advantage of equity and debt, then hybrid funds are the best ones
Those who are novice investors and those who have a low risk profile are often advised to look at hybrid funds for higher returns and lower risks. A hybrid mutual fund invests in both debt and equity asset classes to provide diversification and reduce concentration risks. These funds provide higher returns than a debt fund and have lower risks than an equity fund. The idea is that the equity component will provide higher returns while the debt component will help the fund during market volatility.
Hybrid funds invest in a number of products that include stocks, government securities, treasury bills, and corporate bonds to provide investors with exposure to debt and equity.
Different kinds of hybrid funds
Earlier, these funds were classified based on their equity exposure. Now, these are classified based on their asset allocation. The different kinds of hybrid funds include:
Equity-Oriented Hybrid Funds
These are funds that predominantly invest in equity-linked financial products. More than 65% of the assets of these funds is invested in equities.
Debt-Oriented Hybrid Funds
These funds invest mostly in debt securities. At least 60% of the assets are invested in debt financial products.
Balanced Hybrid Funds
These are funds that invest anywhere between 40% and 60% in equity and debt. They aim to provide higher returns using equity while reducing risks using debt.
Dynamic Asset Allocation or Balanced Advantage Funds
These funds keep their asset allocation dynamic. So, they invest based on the markets. The funds can shift between 100% debt and 100% equity asset class.
Monthly Income Plans
These funds predominantly invest in debt related instruments with minimal equity exposure. They aim to provide regular income for investors through dividends declared from profits.
These funds try to optimise the returns by purchasing securities at a lower price in one market and selling them in another market for a higher price. If there are no arbitrage opportunities, the fund will invest in debt products.
Multi Asset Allocation Funds
These funds invest in at least three asset classes. The investment is a minimum of at least 10% in each of them. Their aim is to provide diversification by investing across asset classes.
Aggressive Hybrid Funds
These funds need to invest at least 65% to 80% of their assets in the equity asset classes and the rest in the debt asset class. They provide a possibility of high returns at reduced risk through the small allocation to debt. They benefit from the taxation applicable to equity-oriented schemes.
Equity Savings Funds
These funds invest in equity, derivatives, and debt. Derivatives are used to reduce the volatility of stock investments and provide stable returns. These funds invest 65% to 100% in equity assets and the rest in debt asset classes.
Which hybrid fund to choose
The hybrid fund that you need to choose will depend on your risk profile, financial requirements and time horizon for your financial goals. You can consider the tax efficiency if you are in the higher tax bracket.
If you are investing for six months to one year, arbitrage funds can be used. These are classified as equity funds for tax purposes. You can take advantage of long-term capital gains taxation if you hold them for more than a year.
If you are looking to invest for 1-3 years, equity savings funds can be used. These are funds that offer higher returns when compared to other hybrid funds. Note that only those with medium to high risk profile should consider these funds as the equity exposure is higher. You can also invest in balanced advantage funds. However, to make the most of these funds you will need to remain invested for at least three years. If you want to invest in Balanced hybrid funds, consider the maturity of the debt securities in the fund’s portfolio.
Looking to invest for 3-5 years’ time frame?Then, go for balanced advantage funds. They are not aggressive hybrid funds and can provide higher returns than equity savings funds and conservative hybrid funds if you remain invested for five years.
If you want to invest in these funds for more than 5 years, you can choose any of the hybrid funds as most of them do equally well in the long term. However, arbitrage and equity savings funds might provide lower returns in the long run because of their exposure to derivatives. Balanced advantage funds can be considered by very aggressive investors while aggressive hybrid funds are for those with a medium risk appetite.
Not sure about which fund to choose? Get in touch with your consultant at wealthzi.com.