What are Hybrid Funds

There are many different types of mutual funds available to investors. As a versatile option, hybrid mutual funds offer a combination of different investments. By combining the characteristics of equity and debt funds, these funds allow investors to maintain a diverse portfolio under one scheme. Furthermore, hybrid funds come in a variety of types. Let’s explore in detail what are hybrid funds.

Hybrid funds meaning

The hybrid fund is a type of mutual fund that invests in more than one asset class. It can be a combination of equity and debt, equity and gold, real estate or even a combination of all three. The asset allocation and proportion of each hybrid mutual fund scheme are determined by the investment objective of the fund.

Features of a hybrid fund

The key features of hybrid funds are:
 

• Asset allocation

  These funds combine equities with bonds and sometimes alternative assets like gold and real estate to create a diversified asset allocation. The aim of this blend is to achieve a balance between risk and reward. Equities are potential growth sources, while fixed-income securities are stable sources of income. Asset class proportions vary depending on the fund's objective, which can be conservative or aggressive.
   

• Risk management

  A hybrid fund reduces risk by diversifying investments across multiple asset classes. In downturns, fixed-income components provide a cushion, while equity components capitalise on market upswings. A balanced approach makes hybrid funds suitable for investors with moderate appetites for risk, as they smooth out volatile equity markets.
   

• Income generation

  A hybrid fund can generate income through interest from bonds and dividends from equities. Some hybrid funds are designed to focus more on regular income, suitable for investors who want a steady cash flow. High-yield bonds or dividend-paying stocks are often included in these funds in order to balance income needs with capital appreciation potential.

Types of hybrid mutual funds

Hybrid funds are classified as follows based on their asset allocation:
 

• Aggressive funds: Hybrid funds that invest a majority in equity are known as equity-oriented funds. It must have at least 65% equity. There are no restrictions on market cap or sector; it can be in any industry. Debt and money market instruments account for 35%.

• Conservative funds: A debt-oriented fund that invests primarily in fixed-income instruments, such as bonds, government bonds, and debentures. At least 60% must be debt, and the remaining 40% must be equity.

• Arbitrage funds: The concept of arbitrage is to buy in one market and sell in another, leveraging a price difference. In arbitrage funds, stocks are bought on the cash market and sold on the futures market. When there is no arbitrage opportunity, it invests mostly in debt.

• Balanced funds: These funds typically have 40-60% equity and debt. Balanced funds can have 40% equity and 60% debt, or any combination in between. Fixed-income instruments allow you to reduce equity-related risks while gaining capital.

• Equity savings funds: These hybrid funds invest in stocks, derivatives, and debt instruments to reduce risk. They reduce volatility and deliver higher returns by hedging risky positions with derivatives.

• Multi-asset allocation funds: They invest across three asset classes. They also invest in gold to protect against inflation. The fund must have at least 10% in each asset class.

• Dynamic asset allocation/Balanced advantage fund: This type of fund gives fund managers a lot of flexibility. Asset allocation can change from 100% equity to 100% debt and any combination in between.
   

Unit linked insurance plan (ULIP) is another similar option. It combines insurance and investment; policyholders can invest in equity, debt, or a mix of both, along with life insurance. In addition, ULIPs offer flexibility since investors can switch funds based on their risk appetite, market conditions, or changing financial goals.

How does a hybrid funds function?

Hybrid funds function in the following manner:
 

Step 1: Allocation across asset classes
A hybrid mutual fund invests in equity and debt, and sometimes in gold, to create a balanced portfolio.

Step 2: Role of equity investments
The equity portion helps the fund grow by benefiting from long-term market gains.

Step 3: Role of debt investments
The debt portion provides stable returns and reduces price fluctuations.

Step 4: Risk balancing through diversification
Debt returns help cushion losses during market downturns. The mix of equity and debt balances risk better than a single asset.

Step 5: Overall portfolio stability
By combining equity and debt, hybrid funds lower risk while offering steady growth.

Who should consider investing in hybrid funds?

Various types of investors may benefit from hybrid mutual funds due to their flexibility and diversification. The following types of investors may be interested in investing in a hybrid mutual fund:
 

• New investors: A hybrid mutual fund could be a suitable investment option for someone just starting out with mutual funds. Because it's a combination of an equity fund and a debt instrument with a low to medium level of risk. Also, it lets first-time investors slowly and gradually learn about the equity market.

• Medium-term investors: Investing in hybrid funds can also be a good option for investors with a medium-term investment horizon of 3 to 5 years. It's mostly because hybrid funds have lower volatility risk than equity funds.

• Retired persons: In a debt-oriented hybrid fund, the volatility risks are low, so it helps to generate stable returns without much fluctuation, so retirees can benefit from it.

• Short-term investors: Investing in arbitrage or conservative funds can be a good option for investors who want to invest their money for less than a year.

Tax effects of hybrid funds

For taxation purposes, hybrid mutual funds are categorised into equity-oriented schemes and other schemes. A fund is said to be equity-oriented if it invests a minimum of 65% of its total assets in equity-related instruments. All other hybrid schemes are classified under other schemes.
 

Taxation of equity-oriented hybrid funds

• Long-Term Capital Gains (LTCG):
  In case of equity-oriented hybrid funds, if it is held for more than one year, then gains can be classified as Long-Term Capital Gains (LTCG). For such gains above ₹1 lakh in a particular financial year, there is a tax* of 10%, which is levied without indexation. In other words, gains below ₹1 lakh are exempted from tax*.

• Short-Term Capital Gains (STCG):
  If the fund is held for less than one year, the gains are treated as STCG and taxed at 15%.
   

Taxation of other hybrid funds

The taxation of hybrid funds other than equity-oriented schemes changed with effect from April 1, 2023.

Conditions for taxation of hybrid funds except equity-oriented funds also underwent a change with effect from April 1, 2023.

If purchased prior to April 1, 2023

• Long-Term Capital Gains (LTCG)
  If such income is retained for periods exceeding 36 months (3 years), it becomes a long-term capital gain, which is liable to tax* at a flat rate of 20%, along with indexation benefits.

• Short-Term Capital Gains (STCG)
  If the units are held for a period of less than 3 years (36 months), the resultant profits are considered short-term capital gains and are taxed according to the tax* rate applicable to the investor’s income.

If purchased on or after April 1, 2023

For all other mutual funds except equity-linked schemes, gains will be classified as short-term capital gains irrespective of the period for which the capital is held. The gains will be taxed based on the income tax* bracket under which the person falls. There is no indexation advantage.

Conclusion

Hybrid mutual funds invest in more than one asset class, such as equity and debt. This helps balance risk and returns. Diversification reduces the impact of market volatility. Different types of hybrid funds suit different risk levels and investment goals. Taxation depends on asset allocation and holding period. Investors should understand these factors before investing. Overall, hybrid funds are suitable for those seeking stable growth with controlled risk.