Mutual funds: Factors to consider before investing in hybrid funds

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Published: December 6, 2019 12:38:50 AM

If you are looking to earn a higher return than a debt fund but keep the risk lower than an equity fund, a hybrid fund can address your investment requirement

hybrid funds, investing in hybrid funds, debt assets, LTCG, financial goals, equity assets, equity fundIf the fund manager allocates more than 75% of a hybrid fund’s resources into debt assets, it would fall under the category of debt-oriented hybrid funds.

An investor may not always want to take an overly aggressive or an excessively conservative investment approach to achieve his financial goals. There are situations he may want to strike a balance in his investment portfolio. In that case, investing in a hybrid mutual fund could come in handy. So, if you are looking to earn a higher return than a debt fund but keep the risk lower than an equity fund, a hybrid fund can address your investment requirement.
Hybrid funds focus on investments in three types of asset classes – equity, debt, and gold. Depending on your risk appetite, return expectations and financial goal, you can invest in the appropriate hybrid fund. That being said, there are various types of hybrid funds in the market; but we will discuss the three most popular ones in this article, i.e., equity-oriented hybrid funds, debt-oriented hybrid funds and dynamic funds. Let’s explore each of these in detail.

Equity-oriented hybrid funds

A hybrid fund that invests more than 65% of its corpus in equity assets is known as an equity-oriented hybrid fund. The remaining corpus is invested in debt assets with a little reserve that can be kept in hand as cash. These funds are attractive for investors who are looking for a higher return than gold but also want to minimise the investment risk.
The returns on equity-oriented hybrid funds are taxed like equity funds, i.e. long-term capital gains (LTCG) are taxed at 10% on gains above Rs 1 lakh while gains lower than Rs 1 lakh are treated as short-term capital gains (STCG) and taxed at 15% booked during the relevant financial year.

Debt-oriented hybrid funds

If the fund manager allocates more than 75% of a hybrid fund’s resources into debt assets, it would fall under the category of debt-oriented hybrid funds. These funds invest in debt assets like treasury bills, money market instruments, bonds, etc. They come with the option of regular income which is paid as a dividend. Another choice is to opt for the growth option in which such dividends are reinvested for capital appreciation.

As a major portion of the corpus is invested in deb assets, debt-oriented hybrid funds carry lower risk than other hybrid funds. You can invest in such a fund if your risk appetite is low or if you are a retiree (or even close to the retirement age) and are looking for a higher return than pure debt funds. Debt-oriented hybrid funds are taxed at 20% with indexation benefit on LTCGs and according to investor’s applicable slab rate for the STCGs.

Dynamic asset allocation funds or dynamic funds

Equity and debt-oriented hybrid funds have restrictions when it comes to allocation of its resources into either equity or debt assets respectively. But if you are looking for a hybrid fund that has the freedom to invest its entire resources into debt or equity in any proportion, you may opt for a dynamic hybrid fund. Dynamic hybrid funds give flexibility to the fund managers to allocate their resources to debt assets when equity assets are overpriced or switch back to equities when they are undervalued. The fund manager gets the flexibility to switch funds within equity funds.
These funds are an attractive investment option for investors who want to park their money for a very long tenure. Do note that dynamic funds are usually treated like equity funds from tax perspective if their exposure to equity assets is maintained over 65%; however, the allocation in equity and debt assets may vary as per the market condition.

You should strictly focus on the demands of your financial goal(s) and accordingly select the appropriate hybrid fund for your investment. For example, if you require high returns and you are ready to take a high risk for that, you may want to go for an equity-oriented hybrid fund. However, if your risk appetite is low, you can go for a debt-oriented fund. And if you want to avail the benefit of flexible auto-balancing between debt and equity assets, you may find the right investment match in a dynamic asset allocation fund.

Hybrid funds can prove to be useful even for those investors who don’t want to look after the asset allocation in their investment portfolio .

The author is CEO, BankBazaar.com

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