Are you risk averse? Give hybrid mutual funds a chance

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Published: March 27, 2017 3:45:43 PM

Risk mitigation should be one of the core objectives for investors who put their hard-earned money in various asset classes in order to earn returns. Mutual fund investment is exposed to market risk and investment in a specific class of the fund may lead to losses if the market conditions are not favourable.

Diversification means distributing the investment in different investment avenues.

Risk mitigation should be one of the core objectives for investors who put their hard-earned money in various asset classes in order to earn returns. Mutual fund investment is exposed to market risk and investment in a specific class of the fund may lead to losses if the market conditions are not favourable. The best-performing mutual funds use diversification as a tool to minimize risk. Diversification means distributing the investment in different investment avenues.

For example, the investment could be made across the same asset class such as equity mutual fund with a diversified portfolio that invests in only equities, but there is diversification in terms of segments or as per market capitalisation such as large cap, small cap etc. But such investments are still exposed to risk related to that specific asset class. Therefore, for greater diversification, you must also invest in low-risk investments. This is where hybrid mutual funds come in as they invest across asset classes, assuring high returns along with safety of capital.

What is a hybrid fund?
A mutual fund which invests the corpus into a mix of several asset classes such as equities and bonds is called a hybrid fund. Hybrid reflects the composure of the fund being more than one underlying asset class. As an investor, your capital is being invested in a mix of equity and bond instruments. As a hybrid fund investor, while you gain through equity assets when the markets rise, you suffer fewer losses due to your bonds assets when the markets lower.

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Types of Hybrid Funds
Broadly, hybrid funds are of two types: equity-oriented hybrid funds, and debt-oriented hybrid funds. Equity-oriented hybrid funds invest a major part of the corpus in the equity segment while the rest goes to the debt segment. The exposure in equities is around 65%, but in some cases, a fund may get the mandate to invest up to 75% or 80% of the corpus. Equity hybrid funds could adopt an aggressive or conservative approach, depending on their pattern of investment.

Equity-oriented hybrid funds with a conservative approach could invest in large cap stocks to lower volatility risks, whereas with an aggressive approach, the fund could increase its exposure in mid-cap stocks for higher returns.

Debt-oriented hybrid funds increase the majority of their corpus in debt instruments such as sovereign bonds and corporate deposits, and cap their equity investment at around 30%. The purpose of such investment is to keep the capital safe while generating a higher post tax returns than the prevailing fixed deposit rates.

There are some hybrid funds which also invest in gold along with equity and debt instruments. But the approach remains the same: to diversify the investment portfolio, reduce risks, and increase returns for the investor.

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Why should you invest in a hybrid fund?
The best reason to invest in a hybrid fund is that you can diversify the investment just by investing in a single fund. Often, investors seek a combination of several mutual funds with a variety of underlying asset classes for their investment diversification. But under a hybrid fund, these needs are met easily.
Here’s a look at some popular hybrid funds.

How to invest in a hybrid fund
If your sole reason for investing in a hybrid fund is to minimize risks and for short to medium-term, then debt-oriented hybrid funds could be the best option for you. It may provide returns above the prevailing deposit rates, and your risks would be moderate. But if your objective is to get high returns and if your risk appetite is moderate to high, then equity-oriented hybrid funds could be your option.

Basically, if the equity market is expected to be in a bull phase and the debt market is expected to remain stable or bearish, then equity hybrid funds would be the best bet. Similarly, if the equity market is expected to stay flat or be bearish, debt markets may be expected to perform better, so invest in debt-oriented funds.
If you are planning to invest in any mutual fund for the first time, a hybrid fund could be a good starting point for you. However, you must pick your fund based on your tenure of investment, investment objective, risk appetite and return expectation.

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Tax implication of hybrid fund investments
Equity-oriented hybrid funds, where the corpus allocation towards equity assets is 65% or more, is treated as an equity mutual fund for tax treatment. Investments over a one-year tenure qualify as long-term investments and thus become tax-free. If redeemed within a year, they qualify for short term capital gains (STCG) tax at 15%.
Conversely, debt-oriented hybrid funds are taxed as debt mutual funds where long-term capital gains need to be paid on investments older than three years (at 20.6% with indexation benefit, and 10.3% without indexation), whereas STCG is paid as per slab rate.

(The author is CEO, BankBazaar.com)

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