Introduction to Hybrid Funds:

What are Hybrid Funds

Hybrid Mutual Funds invest in multiple asset classes like equity (domestic and international stocks), debt, gold, and units of Real estate investment trusts (REITs) & Infrastructure Investment Trust (InvITs).

Depending on the fund's strategy, the fund may invest in any two or three of these asset classes in combination. For instance, some of funds may invest in a combination of equity and debt while others (Multi Asset Allocation) may invest in Equity, Debt, and Gold.

What is the risk involved in Hybrid Funds?

Hybrid Funds may help to reduce the downside volatility by investing in a mix of assets. The extent of downside protection will depend on the equity exposure of the fund. So these funds are not completely immune to volatility.

Equity-Oriented Hybrid Funds

Hybrid Funds which have a minimum equity exposure of 65% are taxed as Equity Funds. They attract short term capital gains tax of 15% plus cess if investments are sold before 12 months. Investments sold after one year qualify for Long Term Capital Gains Tax. Capital gains above Rs 1 lakh are taxed at 10% which means gains of up to Rs 1 lakh are tax-free. Tax on Distributed Income under IDCW Option is taxed at your slab rate. Arbitrage Funds, Equity Savings Funds, Aggressive Hybrid Funds and Balanced Advantage Funds/Dynamic Asset Allocation Funds are typically Equity-oriented Hybrid Funds.

Debt Oriented Hybrid Funds

Hybrid Funds which invest less than 35% in equity will attract Debt Taxation. Capital gains on investments made after April 1, 2023, will be taxed at the marginal rate. Hybrid Funds which invest in the range of 35% to 65% will be eligible for LTCG of 20% with indexation benefit. Conservative Hybrid Fund is an example of Debt-oriented Hybrid Fund. Tax on Distributed Income under IDCW Option is taxed at your slab rate.

Categories of Hybrid Mutual Funds

• Balanced Advantage Fund:

  These funds have the leeway to manage their debt and equity exposure as per the fund's strategy. Most of the funds in this category maintain equity exposure of 65% to qualify for equity taxation. These funds change their equity and debt exposure based on the valuations of the market. In simple terms, if the valuations become expensive the fund may decrease equity exposure and increase debt exposure. Similarly, if valuations become attractive, these funds may increase equity exposure. A key metric used to determine the valuations is Price to Earnings Per Share (P/E) ratio. These funds carry Very High Risk and are suitable for investors who have at least a five-year investment horizon.

• Equity Savings:

  Equity Savings Fund invest in equity, debt, and arbitrage opportunities. These funds carry Low to Moderate risk. Equity Savings Funds may be suitable for investors with moderate risk appetite who are generally looking for safety as well as some capital appreciation. These funds invest in the range of 65% (minimum) to 90% (maximum) of assets in equity (including arbitrage) and 10% (minimum) to 25% (maximum) in Debt and Money Market instruments. These Funds carry Low to Moderate Risk.

Arbitrage :

Arbitrage Funds invest in arbitrage opportunities with a minimum investment of 65% in equity and equity-related instruments. These funds are taxed as Equity Funds. These funds exploit the arbitrage opportunities that exist between the cash and derivatives market as well as within the derivatives segment of the market. Arbitrage strategy simply means simultaneously purchasing and selling the same number of shares in the equity spot market and the equity futures market of the same security to profit from the price difference. When arbitrage opportunities are not available, these funds can also invest up to 35% in short-term debt securities or money market instruments. These funds typically carry Low Risk.

• Aggressive Hybrid:

  As compared to Balanced Hybrid Funds, Aggressive Hybrid Funds take higher exposure to equity which ranges from 65% (minimum) to 80% (maximum). The remaining portion is invested in Debt instruments in the range of 20% (minimum) and 35% (maximum). Investors should have at least a five-year time horizon while investing in these funds. These funds carry Very High Risk.

• Balanced Hybrid

  These funds are suitable for investors who wish to have exposure to equity and debt and are willing to take some risk. As compared to Conservative Hybrid Funds, Balanced Hybrid Funds take a higher exposure toward equity. They invest:

  • Equity: 40% (minimum) to 60% (maximum)

  • Debt: 40% (minimum) to 60% (maximum)

• Conservative Hybrid

  Conservative Hybrid Funds are generally suitable for risk-averse investors who prefer the stability of Debt Funds but at the same time wish to participate in equity. They invest:

  • Equity: 10% (minimum) to 25% (maximum)

  • Debt: 75% (minimum) to 90% (maximum)

  These funds carry Moderately High Risk.

• Multi Asset Allocation

  Multi Asset Allocation Funds invest in three asset classes with a minimum allocation to each asset class at 10%. Most Multi Asset Allocation Funds typically invest in Equity, Debt, and Gold. The advantage of having gold in the portfolio is that the yellow metal has a low correlation with Equity and Debt, which may help in diversifying the portfolio. Gold also acts as a hedge against inflation and adverse macro events. These funds carry Very High Risk.

How are Hybrid Equity Funds taxed?

Hybrid MF (investing >35% and <= 65% in Domestic equity listed on stock exchange) – unlisted units

Investments before 1st April 2023

Redeemed between 1st April 2024 and 22nd July 2024

• Holding period (To qualify for LTCG): > 36 months

• Base STCG Tax rates(*): Slab Rate

• Base LTCG Tax rates(*): 20% with indexation benefit

Redeemed on or after 23rd July 2024

• Holding period (To qualify for LTCG): > 24 months

• Base STCG Tax rates(*): Slab Rate

• Base LTCG Tax rates(*): 12.50% with indexation benefit

Investments after 1st April 2023

Redeemed between 1st April 2024 and 22nd July 2024

• Holding period (To qualify for LTCG): > 24 months

• Base STCG Tax rates(*): Slab Rate

• Base LTCG Tax rates(*): 20% with indexation benefit

Redeemed on or after 23rd July 2024

• Holding period (To qualify for LTCG): > 24 months

• Base STCG Tax rates(*): Slab Rate

• Base LTCG Tax rates(*): 12.50% with indexation benefit

Plus surcharge and cess as may be applicable on the above rates.

How to choose a Hybrid Fund

• Assess your risk appetite

• If you have a low risk appetite and still wish to participate in equity, Conservative Hybrid Funds or Equity Savings Funds may be ideal to suit your goal.

• Check the equity exposure of the fund. Look at the last three year or five year average equity exposure of the fund. This may help you assess the risk-return payoff in conjunction with your own risk appetite.

• Funds that maintain equity exposure of 65% get equity taxation status. Funds that maintain equity exposure of less than 65% are taxed as debt funds. Take into account the tax aspect before choosing a fund/category.

• Compare funds against their peer set within the same category as the investment strategy of each category differs.

• Do not invest merely by looking at the past return.

Frequently Asked Questions

Balanced Advantage Fund is a sub-category of Hybrid Funds. Balanced Advantage Funds (BAF) are also called Dynamic Asset Allocation Funds. A unique aspect of Balanced Advantage Fund is that they can change their asset allocation based on the prevailing valuations in the market.

Hybrid Funds invest in both asset classes—equity and debt. However, the exposure would vary depending on the category of Hybrid Fund. For instance, Conservative Hybrid Fund invest in the range of 75% to 90% in Debt and the remaining 10%-25% in equity. Aggressive Hybrid Funds on the other hand invest 65%-80% in equity and the remaining 20%-35% in debt. They can be classified as Debt-oriented (less than 65% equity exposure) or Equity-oriented (minimum 65% equity exposure).

Each Hybrid Fund category is different based on the investment objective and strategy. You need to choose a fund which suits your goal and risk appetite. Consult a financial advisor to understand which fund suits your goals.

Hybrid Funds which invest a minimum of 65% in equity are taxed as equity funds. Hybrid Funds which invest below 65% in equity attract debt taxation.

The degree of risk varies as per the equity exposure and the investment strategy of the fund. For instance, Arbitrage Funds carry relatively low risk while Aggressive Hybrid Funds carry relatively high risk.

You can invest in Hybrid Funds through an Association of Mutual Funds in India (AMFI) or Securities and Exchange Board of India (SEBI) registered Mutual Fund Distributor, banks, online investing platforms, demat account, Mutual Fund Utility platform and AMC websites.

This category offers seven types of funds. Except Balanced Advantage Funds (BAF), each category manages its exposure to different asset class within a pre-defined range set by Securities and Exchange Board of India (SEBI).

For instance, Multi Asset Allocation Funds have to invest a minimum of 10% each in three asset classes. While the fund manager will keep the minimum allocation to each asset class at 10%, the remaining allocation can be skewed towards any of the three asset classes depending on the discretion of the fund manager.

Thus, the return profile of each fund within the same category will be different based on the exposure to each asset class and its performance during that period. For instance, a portfolio with high cash/debt holding could protect the downside when markets correct. On the other hand, a portfolio skewed predominantly towards equity could outperform when markets run up sharply in comparison to funds that have low equity holding during that time period.

Essentially, Hybrid Funds are meant for those who are looking for exposure to multiple asset classes through one fund. Investors who are not sure about how much they wish to allocate to debt and equity and have a five-year plus investment horizon may consider Balanced Advantage Funds which manage the asset allocation in equity and debt as per the market valuations. Investors who have a short to medium term investment horizon can consider Arbitrage Funds.

Each fund is different and you need to choose a fund which meets your investing goal. Consult your financial advisor to understand which funds suit your risk appetite, time horizon and goals.