Investors can be classified into two major types: conservative and aggressive. Aggressive investors, who are willing to take risks, opt for equity-oriented funds. On the other hand, conservative investors who want to minimize their risks opt for debt-oriented funds. 

Now, what about investors who want the best of both worlds - high returns as well as capital protection? This is where hybrid funds come into the picture. 

Here, in this guide from CreditMantri, we introduce what are hybrid funds – their types, benefits, how they work, factors to consider before investing in hybrid funds and more. 

What is a hybrid fund?

As the name implies, a hybrid fund offers the best of both worlds. It ensures capital protection as a part of your investments are in debt funds. The remaining portion of your finances is in equities, thereby offering you the potential to generate returns.

To summarise it, a hybrid fund offers higher returns when compared to debt funds, but is not as risky as pure equity-oriented funds. It achieves diversification while reducing risks. 

The Working of Hybrid Funds 

A hybrid fund is a type of mutual fund. Just like all other mutual funds, you invest in the plan via a SIP or one-time lump sum investment. The fund manager invests the funds in varying proportions in debt and equity, based on the fund type. The fund manager then makes market decisions on your behalf. The team sells/buy securities using your funds, thereby helping you build your wealth. 

Who is it for? 

  • Ideal for Conservative Investors 

Hybrid funds are ideal for conservative investors who do not want to take aggressive risks but wish to generate higher returns. Since a portion of your investment is in equity funds, hybrid funds generate better returns when compared to debt funds.

On the other hand, the debt component of hybrid funds protects investors from volatile market fluctuations, offering capital protection. When compared with equity funds, hybrid funds provide stable returns without risking the total burnout of the capital. 

  • Ideal for Less Conservative Investors 

Less conservative investors who can afford to take minimal risks can get the best out of hybrid funds. Since hybrid funds have an equity component, they have the potential to generate higher returns when compared to pure debt funds. 

Classification of Hybrid Funds based on Asset Allocation

Hybrid funds are divided into various types based on asset allocation. Let’s take a closer look at the major types of hybrid funds:

  1. Equity-oriented Hybrid Funds 

As the name implies, these funds have a higher equity component. Hybrid funds that invest 65% of its assets in equity and the rest in money market instruments and debt, then it is known as an equity-oriented hybrid fund.

The equity portion of the fund is invested across industries like real-estate, automobile, banks, FMCG, healthcare and finance based on their market cap. Or it may be limited to a specific sector.

Ideal for: Less conservative investors 

  1. Debt-oriented Hybrid Funds 

If a hybrid fund invests 65% or more of its funds in debt instruments, then it's known as a debt-oriented hybrid fund. The equity component in a debt-oriented hybrid fund is lesser than the debt component, making it less risky.

The fund manager invests in a variety of debt instruments like bonds, government securities, treasury bills, corporate debentures, and so on. Additionally, to ensure the liquidity of debt-oriented hybrid funds, a portion of the fund is also invested in cash instruments.

Ideal for: Conservative Investors 

Additional Reading : Debt vs. Equity Funding: Analysing the Pros and Cons for Startups

  1. Monthly Income Plans 

As the name implies, monthly income plans (MIP) offer a stable income in the form of dividends. Despite the name "monthly income plan," not all MIP mutual funds offer payouts every month. The investor decides the payout frequency. The investor can choose to receive payouts – annually, half-yearly, quarterly or monthly.  

The exposure to equity in MIP is around 15 – 20%. The rest is invested in debt funds. Some monthly income plans also come with growth option. In such funds, you do not receive monthly payouts. Instead, the dividends are reinvested, helping you grow your corpus.

Ideal for: Investors looking for an additional income in the form of dividends. 

  1. Arbitrage Funds 

In an arbitrage fund, the fund manager maximizes returns by investing in stock purchased at a lower price. He then makes a profit by selling the purchased share for at a profit in another market. 

However, you have to note that arbitrage opportunities are rare and available only for a short time. If no such arbitrage opportunities are available, these funds invest in debt or other cash instruments. Just like debt funds, arbitrage funds are considered highly safe. However, the long-term gains from an arbitrage fund are taxable just like gains from an equity fund. 

Classification of Hybrid Funds based on Risk Profiles

Hybrid funds can also be categorized based on their risk profiles. They are:

  • Conservative hybrid fund – This fund has a higher debt allocation. Nearly 75% to 90% of the asset allocation is for debt instruments, and the rest is invested in equities. 

  • Balanced hybrid fund – A balanced hybrid fund has equal debt and equity allocation. 40% to 60% of the investments are in equities and the rest in debts or vice versa. 

  • Aggressive hybrid fund – In an aggressive hybrid fund, the majority of the fund value is invested in equities (65% to 80%), and the remaining is invested in debt instruments.  

Factors to Consider before Investing in Hybrid Funds 

  1. Hybrid Funds are not 100% Risk-free 

One common misconception is that hybrid funds are risk-free. This isn't true. While hybrid funds are not as risky as equity funds, they are not 100% risk-free. Remember that all hybrid funds have a percentage of equity investments, which come with market risks.

While hybrid funds are less risky than pure-equity funds, you have to exercise due caution and choose the right type of hybrid fund, that suits your risk profile. 

  1. Hybrid Funds do not Guarantee Returns 

Just like all other mutual funds, the performance of hybrid funds depends on the value of the underlying securities. If these securities perform well, then the NAV (Net Asset Value) of the fund increases, else it takes a hit. Remember that market fluctuations impact the performance of hybrid funds, which, in turn, can affect your returns.

  1. Choose Hybrid Funds with a Low Expense Ratio 

The expense ratio of a mutual fund is the fee charged by the fund house for managing your portfolio. The lower the expense ratio, the higher the returns for the investor. So, make sure to compare similar hybrid funds, and choose the fund that has a lower expense ratio. 

  1. Hybrid Funds are ideal for investors with a Medium-Term Investment Horizon 

If you have an investment horizon of five years or more, then you can opt for hybrid funds. Hybrid funds are suited for investors who are saving for more significant financial goals like purchasing a car, funding a child's education, and so on. Additionally, hybrid funds that offer dividends are suitable for retirees who are looking to boost their post-retirement income.

  1. Taxation on Hybrid Funds 

The taxes on hybrid funds are divided into two components. The equity portion of hybrid funds is taxed just like other equity funds. LTCG (Long-term capital gains) above Rs. 1 lakh attract taxes at 10%. STCG (Short-term capital gains), on the other hand, are taxed at 15%.

The debt component is taxed just like regular debt funds. The long-term capital gains from the debt component are taxed at 10% without indexation and 20% with indexation. The long-term and short-term benefits from hybrid funds are added to your taxable income and taxed as per your prevailing income tax slab.

Additional Reading : Are mutual funds safe?

Top 10 Hybrid Funds in India for 2020 

Choosing the right hybrid fund to invest in can be quite overwhelming. There are plenty of factors to consider. You need to evaluate different parameters based on your risk appetite, investment horizon, financial goals and more. 

S.No. Fund Name  3 Year Returns     5 Year Returns  
1  Canara Robeco Equity Hybrid Fund 12.51% 10.56%
2  HDFC Hybrid Equity Fund 9.96% 9.70%
3  ICICI Prudential Equity & Debt Fund     10.04% 10.14%
4  Principal Hybrid Equity Fund 11.58% 10.31%
5  SBI Equity Hybrid Fund 12.56% 11.23%

*Note that returns from these funds are subject to change based on market fluctuations. Make sure to choose funds based on your investment goals. 

#Data as on December 2019, from Value Research


Balance your Portfolio with Hybrid Funds 

Hybrid funds combine the best benefits of both equities and debts in a single fund. It gives the securities of debt funds, with the potential of returns of equities. Compare the different types of hybrid funds and choose the right one that matches your investment style and risk appetites.