Hybrid Mutual Funds: Meaning, Types, Benefits, Returns & Taxation

If you are planning to invest in a mutual fund scheme that has the potential to generate high returns but has a lower risk factor than equity funds, hybrid mutual funds might be a good option for you. A hybrid fund lets you invest in different types of assets, thus diversifying your portfolio and minimising the risk involved. 

What Are Hybrid Mutual Funds? 

Hybrid mutual funds invest their assets in a combination of debt and equity securities. Fund managers allocate the assets in such a way that the balance between growth and income is stabilised. Hence, the returns generated and the capital appreciation of the invested funds depend on the asset classes in the fund’s portfolio. 

Besides equity and debt securities, hybrid funds also invest in gold and derivatives. Again, the idea is to provide investors with a balanced palate of risk and return. By investing in a hybrid fund, you can distribute your assets between equity, debt, gold and other types of securities. 

What Are the Types of Hybrid Funds? 

Depending on the investment objective of the fund manager, there are a variety of options of hybrid funds for you to choose from. Here are the types of hybrid funds that are prevalent in the market: 

• Aggressive Fund

As per SEBI guidelines, these funds invest 65% to 80% of the assets in equity and equity-oriented securities. The rest, 20% to 35%, is invested in debt instruments. As a result, the funds invested in debt securities have the potential to earn stable returns at reduced risk while the portion invested in equities holds the possibility of generating high returns due to high-risk market exposure. 

• Conservative Fund

Conservative funds are just the reverse of aggressive funds. These funds invest 75% to 90% of the assets in debt instruments and the rest in equity and equity-related instruments. These funds aim to provide their investors with regular income through debt investments. On the other hand, there’s also a high potential of earning a substantial income from equity investments. 

• Arbitrage Fund

Arbitrage funds invest a minimum of 65% of their assets in equity and equity-related instruments. These funds profit from the price difference of a particular stock in two markets/exchanges. The fund managers purchase stock from one market and sell them simultaneously in another market to gain profits. 

• Balanced Hybrid Fund

These funds allocate 40% to 60% of their assets in equity or debt securities; the aim is to keep a balance between equity and debt instruments. This fund aims to gain capital appreciation through equity investments while balancing the risk with debt securities, hence the name, balanced hybrid fund. 

• Multi-asset Allocation Fund

These mutual fund schemes are allowed allocation of funds in three asset classes with a minimum investment of 10% in each. Asset allocation depends on the strategies of the fund manager. Multi-asset allocation fund provides more exposure to more asset categories. 

• Dynamic Asset Allocation Fund

As the name suggests, the asset allocation of these funds is entirely dynamic, which means they can invest even 100% of the assets either in equity or debt securities. It depends on the market conditions and the financial strategies adopted by the fund manager. 

• Equity Savings Fund

These funds aim to balance risk and return by allocating funds in equity, debt and derivatives assets. They invest a minimum of 65% in equity, at least 10% in debt and the rest in derivatives. Equity assets can provide long-term wealth generation, while derivatives lower the volatility. Debt assets have the potential to provide regular steady returns. 

What Are the Benefits of Investing in a Hybrid Fund?

Most investors aim to balance risk and return in a mutual fund. This is why hybrid mutual funds have gained much popularity in recent years. Here are some benefits of investing in hybrid mutual funds:

• Exposure to asset classes: One of the most beneficial factors of investing in a hybrid fund is exposure to various asset classes – debt, equity, gold and commodities or derivatives. Individuals who wish to invest in different funds to diversify their portfolio and balance the risk associated can instead invest in hybrid mutual funds. 
• Adjustable risk level: There are multiple hybrid mutual funds in the market with varying amounts of assets allocated in different types of securities. Investors can choose any one of them as per their risk tolerance level. These funds offer active risk management from diversified asset allocation. 
• Sufficient diversification: The diversification of a portfolio is not limited to only asset classes. Fund managers also invest in sub-classes of those asset classes. For example, while investing in equity, they consider different types of equity schemes such as growth fund, large-cap, mid-cap, etc. 
• Automatic rebalancing: Investors are not required to invest their time to balance and rebalance their portfolios. Fund managers perform this task as and when required by monitoring market conditions. 
• Low expense ratio: Investing in multiple mutual funds to diversify your investments might incur a high expense ratio. Instead, investing in hybrid mutual funds will incur a lower expense ratio, which will increase profitability. 

Returns on Hybrid Funds 

Investors of hybrid mutual funds can generate stable returns from assets invested in debt securities. On the other hand, they can gain significant capital appreciation on the money that has been allocated for equity instruments. The returns from hybrid mutual funds can vary as per market conditions; however, they are stabilised quickly, thanks to a diversified portfolio. 

Also, there are multiple types of hybrid mutual funds to invest in. Investors can select a hybrid fund whose investment objective aligns with their financial goals. For example, if you wish to generate high returns and have a high risk tolerance, you can go for aggressive hybrid funds. 

Tax Implications of Hybrid Funds 

The taxation of a hybrid mutual fund depends on its asset classes. Here are the tax implications of investing in hybrid funds: 

• Conservative and equity savings hybrid funds follow the debt fund taxation rule. If assets are held for less than 36 months, the gains are considered short-term capital gains (STCG) and are taxable as per the investor’s income tax slab. If held for more than 36 months, the gains are considered long-term capital gains (LTCG) and are taxed at 20% with indexation benefits. 
• Aggressive, arbitrage and balanced hybrid funds follow rules of equity taxation. If your assets stay invested for less than 12 months, gains are considered STCG and are taxed at 15%. If the assets are held for 12 months or more, gains below ₹1lakh are tax-free, but above that are taxed at 10%. 
• In the case of a dynamic fund, the taxation rules apply as per asset allocation. Equity taxation will be applicable if all assets are invested in equity securities. Debt taxation norms will apply if the fund manager keeps the entire fund in debt securities. 

Final Word 

Hybrid funds provide investors with the benefit of having a diversified portfolio. The fund’s portfolio aims to strike the perfect balance between risk and returns. There are different types of hybrid mutual funds with varying degrees of asset allocation. Investors are advised to assess whether a fund’s investment objective is aligned with their financial goals before going ahead with any decision.  

Frequently Asked Questions: 

What are the things you should consider before investing in a hybrid fund? 

Ans. You should consider the following points before choosing a hybrid fund: 

• Expense ratio 
• Exit load 
• Asset allocation 
• Risk diversification 
• Credit quality of the securities 
• Past performance of the fund 

Who should invest in hybrid funds? 

Ans. Hybrid mutual funds can be fruitful for a variety of investors. Amateur investors or conservative investors who wish to invest in equity instruments but want minimum risk involved can choose hybrid funds. 

What is an exit load on hybrid funds? 

Ans. The fund houses sometimes charge a percentage of the unit price of a mutual fund if an investor decides to exit. This is referred to as the exit load that is levied on the investor and is then deposited into the scheme. As an investor, you should consider this load as it can affect the return on your investments. 

Do I need to pay taxes on the dividends earned from hybrid mutual funds? 

Ans. Yes, dividends are taxable at the hands of investors from FY 2020-21. These are to be added to their total taxable income and taxed as per the income tax slab applicable. Additionally, 10% TDS will be deducted if dividends from any mutual fund exceed ₹5000 in one financial year.

What is the best hybrid fund to invest in?  

Ans. To choose the best hybrid fund for you to invest in, you should know your investment goal and risk tolerance level. Consider the fund’s past performance and also track its past annualised returns.