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

This article is a part of our detailed article series on the concept of hybrid mutual funds in India. Ensure you have read the other parts here: Show/Hide

📚 Table of Contents

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• What are hybrid mutual funds?
• How are hybrid funds taxed?
• How does SEBI define hybrid funds?
  • Conservative Hybrid Fund
  • Balanced Hybrid Fund
  • Aggressive Hybrid Fund
  • Dynamic Asset Allocation or Balanced Advantage Fund
  • Multi Asset Allocation Fund
  • Arbitrage Fund
  • Equity Savings fund
• Risk-return profile of hybrid funds
• When to invest in hybrid funds?
  • Conservative Hybrid Fund
  • Balanced Hybrid Fund
  • Aggressive Hybrid Fund
  • Dynamic Asset Allocation or Balanced Advantage Fund
  • Multi Asset Allocation Fund
  • Arbitrage Fund
  • Equity Savings fund

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.

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

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.

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.

When to invest in hybrid funds?

Conservative Hybrid Fund

Use case: These funds have a small allocation to equity and can be suitable for goals due around five years. Once goals come closer, these funds should be exited in favour of safer options.

Balanced Hybrid Fund

Use case: These funds maintain a similar proportion of investments in equity and debt with minor variations. Rebalancing is done when the equity or debt levels move beyond pre-determined limits. There are limited options available in this category and even those should be avoided by investors.

Aggressive Hybrid Fund

Use case: These funds maintain a high allocation to stocks and should only be considered for long term goals. These funds can form the core of a portfolio for long-term goals.

Dynamic Asset Allocation or Balanced Advantage Fund

Use case: These funds change their asset allocation between equity and debt based on market movement and valuation as per the fund manager’s discretion. For example, if the equity market has gone up, then some of the profits will be reinvested into the debt portfolio and vice versa. Over time, such rebalancing is expected to enhance returns and keep risks low. Active funds in this category might not be suitable for most investors since the asset allocation may not match goal-specific risk profile.

Multi Asset Allocation Fund

Use case: These funds can invest in equity, debt and gold (at least 10% in each) and therefore offer diversification amongst these asset classes. The funds provide an easy option to create a diversified portfolio.

Arbitrage Fund

Use case: These funds can be used for goals due within three years. They will give returns similar to a savings bank account and are taxed the same as equity mutual funds. However, there might be some short-term fluctuations since most of these funds hold some bonds.

Equity Savings fund

Use case: These funds can be a good option for short term goals with minimum equity exposure. In contrast with conservative hybrid funds, they have a large arbitrage component as well.