Hybrid Funds come in all shapes and sizes. There are shapes in the form of fund categories like Equity Savings Fund, Balanced Advantage Fund, Aggressive Hybrid Fund, etc. Then there are sizes with funds ranging from 20% allocation to equity of 80%.
What are Hybrid Funds?
The stock markets have moved up by more than 45% since the March 2020 lows, and we have seen huge retail participation in Direct Equities and Mutual Funds. When it comes to Mutual Funds, the most popular investor category continues to be the plain vanilla Equity Funds.
However, if you are a first-time investor, Hybrid Funds would be a far better option. The reason is the concept of asset allocation that these funds work on. Simply speaking, these funds invest in a combination of asset classes like Equity, Debt, Gold, and even international ETFs. This allows you to reap the benefit of any upside on account of the equity exposure and protect the downside by parking some portion of the surplus into debt instruments as well.
Hybrid Funds: When to pick which one?
As an investor, you have choices. In fact, you have too many choices. With 7 sub-categories of Hybrid Funds, it is easy to get confused while deciding where to invest. To make this easier for you, we explain each of the Hybrid Fund sub-categories along with its suitability per your risk profile.
1. Conservative Hybrid Funds
Let’s start with the most cautious of all Hybrid Funds, Conservative Hybrid. The Conservative Hybrid category of funds predominantly invests in Debt instruments. The Equity allocation for these funds can be anywhere between 10% to 25%, while the Debt allocation ranges from 75% to 90%. The Conservative Hybrid Fund’s priority is the safety of capital and hence asset participation is skewed towards Debt instruments.
These funds are suitable for risk-averse investors whose priority is the safety of capital but are willing to take a small allocation into equities, which will provide upside potential to the overall performance of the fund.
2. Balanced Hybrid Funds
The Balanced Hybrid category funds invest 40% to 60% of their assets in Equities and the rest in Debt. This means, at any point, there can be 40% Equities and 60% Debt, or there can be 60% Equities and 40% Debt, or any combination in between.
Balanced Hybrid Funds are suitable for investors with a moderate risk profile, i.e., people who don’t want too big an exposure in a particular asset but don’t want too little exposure as well.
3. Aggressive Hybrid Funds
Aggressive Hybrid Funds are one of the most popular categories in the Hybrid space. This is evident in the assets under each fund category. The aggressive Hybrid Funds have over Rs. 1,10,000 Crores while Balanced Hybrid and Conservative Hybrid together have just about Rs. 25,000 Crores in assets.
The mandate of the aggressive hybrid category allows it to predominantly invest in Equity instruments with an equity allocation of anywhere between 65% to 80% of the total assets. Due to this higher allocation to Equity, this category is ideal for investors with an aggressive risk profile who have a time horizon of more than 5 years. The fund itself comes with some protection. So even if the funds take an exposure of 80% into Equities, the rest 20% in debt or liquid instruments will act as a cushion if the stock markets were to get into a volatile phase.
4. Dynamic Asset Allocation Fund / Balanced Advantage Funds
The Dynamic Asset Allocation Funds have the flexibility to move across asset classes with no limits fixed by the regulator. The allocation between Equity and Debt is “dynamically managed.” It’s “managed” because you get the services of a Fund Management Team that adds a flexibility layer and moves money across the asset classes and it is “dynamic” because the allocation itself depends on the valuation models used by them. So, if you want stability in returns, the dynamic asset allocation funds will give that and that’s why these funds are suitable for first-time investors and even conservative to balanced investors.
5. Multi-Asset Allocation Funds
Multi-Asset Allocation Funds can invest into at least three asset classes with a minimum allocation of 10% into each asset class. The first two are Equity and Debt. Then there are commodities where assets are invested into, there is gold, and there is international exposure as well, all in a single fund. The Multi-Asset Allocation Funds are ideal for investors who understand the advantages and disadvantages of the different asset classes and are keen to grow their wealth with stability and diversification.
6. Arbitrage Funds
Arbitrage Funds are designed to generate returns from mispricing opportunities.
These can happen in many ways. For example, say, the stock is available at Rs. 150 in NSE and at Rs. 151 at BSE. This means if you buy the stock at NSE and instantly sell it on the BSE, you would have made 1 rupee as a profit. Another way is the cash and futures market. The cash market refers to the current price of a security. Arbitrage Funds earn returns for investors from the difference in pricing of stocks between the cash market and the futures market. So, if the stock is expected to go high, the fund manager will buy from the cash market and simultaneously sell in the futures market and vice-versa.
7. Equity Savings Funds
The Equity Savings Funds invest in Equities, Equity arbitrage, and Debt. This is done to keep the minimum investment in equities at least 65% to ensure Equity taxation. These funds also have a minimum allocation of 10% in Debt, which allows for some downside protection along with the arbitrage component.
From a returns perspective, these funds, due to the higher Equity component, tend to perform somewhere between a balanced hybrid and an aggressive hybrid.
So if you are a moderate risk investor and want to have some downside protection but are generally fine with taking a decent exposure into equities, you can opt for these funds.
A good way to look at these different categories of Hybrid Funds is on the basis of your risk profile. Having said that, hybrid funds do an excellent balancing act and are a must-have in your Mutual Fund portfolio, especially if you are new to investing or generally are conservative or moderate in your risk outlook.