No matter what your goals are or what your risk profile is, you can invest easy & make a sound portfolio. In earlier posts I have explained about 3 different kinds of mutual funds: Debt Funds, Equity Linked Savings Scheme Funds (ELSS) & Closed End Funds. In this post I will explain yet another fund category called Hybrid Fund.
There are basically three kinds of investors in the market:
This kind is a complete risk taker. They are willing to take high risks for earning high returns.
This kind is totally risk-averse. They are more interested in capital safety than earning higher returns.
They fall somewhere in between i.e. neither too aggressive nor too conservative. They are willing to take some risk but not a lot of it.
Now, suitable investment options for both aggressive and conservative type of investor is pretty straight forward. Aggressive kind will opt for 100% equity exposure, and conservative types will go for 100% debt exposure.
But what if you fall under the moderate investors category? In other words, those investors who want exposure to both equity and debt funds, so that they can gain good returns with less risk? Well worry not, there is a perfect ready-made solution for you available in the form of Hybrid Mutual Funds.
Hybrid Mutual Funds invest in both equity and debt instruments simultaneously, thereby providing the perfect mix for your portfolio. These hybrid funds are also divided into Equity Oriented Hybrid Funds and Debt Oriented Hybrid Funds.
You can choose between these two based on your risk profile. If you lean more towards safety, but are willing to take little bit of risk in order to earn higher returns as compared to debt funds, you should opt for Debt Oriented Hybrid Funds.
If you are willing to take adequate risk but are also looking for some cushion from a volatile market, you should opt for Equity Oriented Hybrid Funds.
Equity Oriented Hybrid Funds
These funds invest 65% or more of their assets in equity or equity related instruments and the rest in debt instruments. Balanced Funds fall under this category.
Some key advantages of Equity Oriented Balanced Funds over investing separately in equity and debt funds:
- Taxation Benefit
If you invest separately in both debt and equity funds say for three years and then opt for cashing out your investments you will have to pay long term capital gains tax for both your investments. While Equity Long term capital gain tax is nil, you will have to pay 20% with indexation benefit on debt long term capital gains. But if you invest in Equity Oriented Balanced Funds, your entire portfolio will be qualified as equity for tax purposes. This means that despite the presence of debt instruments the entire long term gain will be tax free.
- Asset Allocation
Deciding proper asset allocation is important but maintaining it is also extremely important.
Let’s say at the start of the year you were very considerate with your investments & deliberated over your diversification strategy. You thought “I’ll invest 65% in equities, 30% in debt and 5% in gold certificates” But as the year went by you noticed that stock markets were performing really well. Every month you were dedicating more & more to your equity funds while neglecting the safety net of debt funds. Six months later you realised that 80% of your portfolio was now comprised of Equity Funds – all your planning had gone to waste.
If you are investing in equity oriented hybrid funds you don’t have to worry about a thing as the fund manager will be performing all such tasks. Your equity portion will always remain within the decided limit.
- Better returns with Lower risk
Equity Hybrid funds outperform debt funds & also carry lesser risk than equity-only funds. While the equity portion let’s you take a ride on the roller-coaster of stock market, the debt portion provides a brake-mechanism if the market is in free-fall.
Debt Oriented Hybrid Funds
These funds invest majorly in debt instruments, but in order to earn better returns than debt funds they also have some equity exposure.
Depending on the level of equity exposure these funds can be further divided into three categories:
- Conservative Funds
Under this category, equity exposure is quite low of up to 10%, rest all is invested in debt.
- Moderate Funds
In this equity or equity related instrument ratio is up to 20%, and debt instruments at 80%.
- Aggressive Funds
This category has higher equity exposure of up to 30%, & the remaining allocation is into debt.
Taxation for Debt Oriented Hybrid Funds is similar to that of debt funds. For more details on taxation check out my post on Taxation on income from Mutual Funds.
It is important that you understand what kind of risk profile the hybrid fund is adopting to make sure that it suits you perfectly. For example in equity oriented hybrid funds the minimum equity limit is fixed but the maximum limit is open ended, like some funds might opt for 75% equity, others might opt for 70% or only 65%. Therefore it is up to you to find out how the fund is allocating its assets and decide if you are comfortable with it or not.
Also, some funds limit their equity exposure to large caps only while others can invest primarily in mid and small caps, thereby increasing the risk factor of the fund. So it is vital that you perform proper due diligence, before finalizing your hybrid funds.
This variation can also be found in debt instruments as well, investment duration and the quality of the instrument would determine the level of interest and credit risk in such investments.
So, understand what kind of risk level you are comfortable with and than choose that perfect hybrid funds. Happy Investing 🙂