Looking to invest in debt funds? Why hybrid funds may be a better option

Published: June 16, 2020 10:34 AM

Investors are wary of investing in hybrid funds due to equity exposure. However, hybrid funds also invest in debt, a fact that is often ignored by investors.

hybrid funds, debt funds, mutual fund investment, MF, mutual funds, hybrid fund meaning, hybrid fund categories, types, taxation of hybrid fundsDuring volatile market conditions when an investor is unsure of choosing between equity and debt, hybrid funds provide an excellent investment alternative by not only ensuring safety but also by generating higher returns.

In recent years, debt funds have suffered from a bad rap due to the credit crisis. Though the silver lining is that most of the funds have managed to escape unscathed, but for someone looking to invest in debt, hybrid funds provide a better alternative to pure debt funds.

Investors are wary of investing in hybrid funds due to equity exposure. However, hybrid funds also invest in debt, a fact that is often ignored by investors. All hybrid funds are not alike. Hybrid funds can be categorized into seven categories as defined by SEBI. Amongst these, the Conservative Hybrid Fund, Balanced Hybrid Fund, and Aggressive Hybrid Fund are popular among investors. Conservative Hybrid Funds invest 75-90 per cent in debt, Balanced Hybrid Funds invest 40-60 per cent in debt, and Aggressive Hybrid Funds invest 20-35 per cent in debt.

How does a hybrid fund work?

The objective of a hybrid fund is to construct a balanced portfolio that offers regular income to the investors along with an opportunity for capital appreciation. The investment is made according to the objectives of the scheme and funds are allocated in equity and debt in varying proportions.

Since the portfolio of a hybrid fund also contains debt components, they are preferred by investors having low-medium risk appetite. Depending upon the debt component, hybrid funds can be riskier than their debt fund counterpart and relatively safe from pure equity counterparts. Due to a combination of equity and debt they are able to offer better returns than pure debt funds. The debt component offers stability while the equity component allows the fund manager an opportunity to scout for higher returns.

While most of the top AMC’s prefer to invest only in AAA-rated papers, there are some which also invest in A-rated papers to provide higher returns to the investors. When it comes to debt investments there is no classification on credit quality. The investments are made at the discretion of the fund manager.

Hybrid funds offer investors to benefit from equity and debt mixture. Many investors prefer to invest due to the option of regular payouts. Monthly income plans provided by debt hybrid funds are attractive for someone looking for a regular payout. These funds predominantly invest in debt and only a small portion of assets is invested in equity. The debt strategy comprises investing in call money which provides liquidity, government debt which provides safety and private debt which provide alpha.

Hybrid funds are not entirely immune from the risk because they carry the risk that is proportionate to the allocation of the assets. It is important to analyze the investment strategy of the fund to get an idea of the assets it is likely to invest in.

Hybrid funds are also attractive from the tax perspective. Debt hybrid funds are treated as debt funds from the taxation perspective. Short-term capital gains are taxed according to the tax-slab of the investor while indexation benefit is available for long term gains.

During volatile market conditions when an investor is unsure of choosing between equity and debt, hybrid funds provide an excellent investment alternative by not only ensuring safety but also by generating higher returns. Hybrid funds allow the investor to invest without the hassle of choosing the basket of products or rebalancing the portfolio.

However, like all investments due to the diverse nature of these funds, an investor must consult his financial advisor before investing in hybrid funds.

(By Abhinav Angirish, Founder, Investonline.in)

Disclaimer: This is the personal view of the author. Readers are advised to consult their financial advisor before making any investment.

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