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A primer on hybrid mutual funds: what are they and when to invest in them

Posted on 19 Oct 2022
Author: Sayan Sircar

Tags: Choosing Investments ; Mutual Funds

6 mins read

This article talks about the hybrid mutual fund category in India and shows you which ones to invest in as per your goals.

A primer on hybrid mutual funds: what are they and when to invest in them

What are hybrid mutual funds?

Hybrid funds offer a mix of multiple asset classes (equity/debt/gold/arbitrage/international stocks) in a single fund. The biggest selling points of a hybrid fund are:

tax-free rebalancing: buys and sells inside a mutual fund does not incur any tax.
emotion-free asset allocation changes: many investors miss out on rebalancing either due to lack of active monitoring, knowledge or fear of taxes
one-stop portfolios for certain goals: for very short-term (less than five years) or very long-term goals (more than 10 years), certain hybrid funds can be considered as a part of a 1-2 fund simple portfolio.

This being an introductory article will skip going into examining the three points above but will do so in a future article.

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How are hybrid funds taxed?

Hybrid mutual funds are taxed based on their exposure to equity. Any fund with exposure of 65% or more to Indian stocks or arbitrage will be taxed as an equity fund. All other funds will be taxed as debt funds. Since the percentage allocated to equity may vary over the holding period, the investor has to calculate the allocation to equity over the holding period and calculate the tax accordingly.

How does SEBI define hybrid funds?

As per SEBI, there are the following seven types of hybrid funds:

Conservative Hybrid Fund

SEBI definition: 10% to 25% investment in equity & equity related instruments; and 75% to 90% in Debt instruments

Balanced Hybrid Fund

SEBI definition: 40% to 60% investment in equity & equity related instruments; and 40% to 60% in Debt instruments

Aggressive Hybrid Fund

SEBI definition: 65% to 80% investment in equity & equity related instruments; and 20% to 35% in Debt instruments

Dynamic Asset Allocation or Balanced Advantage Fund

SEBI definition: Investment in equity/ debt that is managed dynamically (0% to 100% in equity & equity related instruments; and 0% to 100% in Debt instruments)

Multi Asset Allocation Fund

SEBI definition: Investment in at least 3 asset classes with a minimum allocation of at least 10% in each asset class.

Arbitrage Fund

SEBI definition: Scheme following arbitrage strategy, with minimum 65% investment in equity & equity related instruments.

Equity Savings fund

SEBI definition: Equity and equity related instruments (min.65%); debt instruments (min.10%) and derivatives (min. for hedging to be specified in the SID).

Risk-return profile of hybrid funds

Risk-vs-return for hybrid funds

It is generally believed that hybrid funds have returned between pure debt and pure equity funds. It becomes interesting if you consider risk along with returns together. Please note that this chart is at a point of time and does not show rolling performance. It shows last three-years’ risk and return.

We can see the risk vs return, using data from Valueresearchonline, has some distinct clusters e.g. for arbitrage and aggressive hybrid. This is expected since both these categories are rigidly defined.

However, the categories of Conservative Hybrid and Equity Savings display considerable dispersion. We will examine them in more detail in a future article. The table below shows a correlation between risk and return for each category at a high level that shows the same conclusion.

Category	Correlation
Aggressive	36.3%
Arbitrage	38.9%
Balanced	31.6%
Conservative	-4.5%
Dynamic	32.8%
Equity Savings	-3.7%

We are also showing the current position of the Nifty 50 index funds at the intersection of two lines. Our aim, for long-term goals, should be to be invested in funds that lie above and left of the intersection i.e. in the top left quadrant. Funds here have demonstrated lower risk and higher returns than the Nifty 50 index fund. This aim is difficult to achieve since the funds will drift relative to the index but that will be something we will revisit in a future article.