When we talk of equity and debt funds, we are talking about two extremes of the market. There is a third category of funds which actually combine equity and debt in different proportion. So, if you are an aggressive investor wanting a little bit of stability, then equity-oriented hybrid funds could be the answer. If you are a conservative investor looking to get that little bit extra through equity funds, then conservative hybrid plans could be the product for you. Let us understand how these hybrid mutual funds like equity-oriented hybrid funds and conservative hybrid plans help fill a gap in the mutual funds market.
Hybrid funds, as the name suggests, invest in a mix of equity and debt. Hybrid funds do the job of asset allocation on your behalf. It also gives you the added benefit of professional fund management and professional asset selection. Hybrid funds have given returns of between 9% and 2% over a 10-year period depending on the equity exposure.
How equity balanced funds play the tax advantage game smartly
Hybrid funds (equity balanced) have attracted investors because of the favourable tax treatment given to equity balanced funds. Balanced funds with a minimum exposure of 65% to equities are classified as equity funds. This gives them preferential treatment both in terms of taxation of dividends and capital gains.
Dividends paid out by equity funds and debt funds are tax free in the hands of investors, but debt funds entail a higher incidence of DDT (Dividend distribution tax) on the dividends paid out. For example, dividends declared by debt funds attract 29.12% DDT while dividends by equity funds attract only 11.648% DDT. Capital gains on a debt fund are classified as short term if it is held for less than 3 years and taxed at your peak rate. If you hold the debt funds beyond a period of 3 years, then it becomes long term capital gains and is taxed at 20% with the benefit of indexation. On the other hand, equity funds capital gains are treated as long term if they are held for more than just 1 year. In case of equity funds, short-term gains are taxed at 15%. Effective fiscal year 2018-19 all equity funds will attract a long-term capital gains (LTCG) tax at the flat rate of 10% without the benefit of indexation. However, this will apply after the long-term capital gains have crossed Rs 1 lakh in the financial year.
With hybrid funds you can have the cake and eat it too
Balanced funds have managed to mix a bit of aggression with their asset mix. For example, the equity mix has been slightly tweaked to focus more on high performance sectors and go underweight on laggards. Similarly, the equity stake has been tweaked from 65% to as high as 75% in some cases to make the best of the equity market rally. These types of funds are actually a subset of hybrid funds and are called dynamic asset allocation funds wherein the fund manager has the leeway to shift the allocation to debt and equity according to the market view.
What to opt for — equity-oriented hybrid, dynamic or conservative hybrid?
In the hybrid funds category, there are three further sub-classifications that investors can look at. At the outset, there is the equity-oriented hybrid fund that has a 65% to 80% exposure to equity and the balance to debt. A balanced fund typically tends to keep its exposure to equity and debt fairly static to get the full tax benefits of an equity fund. Equity-oriented balanced funds are attractive due to tax benefits on par with equity funds. A dynamic fund has the leeway to switch its equity/debt mix aggressively. There are times when dynamic funds tend to outperform balanced funds, but they are more aggressive in nature and, therefore, more risky. A dynamic fund can go up to 100% in debt and 0% in equity and vice versa, depending on its view. Conservative hybrids have a larger exposure to debt and a smaller exposure to equity. Conservative hybrids tend to be structured as monthly income plans. These monthly payouts are normally structured as SWPs to minimize the tax impact.
In the latest mutual fund categorization, SEBI has insisted upon most of the classifications being standardized. Interestingly, arbitrage funds have also been classified as hybrid funds since they are equity-based but have the essential characteristics of a debt fund. The choice is wide and you can make those small tweaks to create combinations that perfectly suit you. Essentially, hybrids mix and match the two extremes of equity and debt to give you that added advantage in the financial markets. In the process, you can manage your journey towards your goals a lot better and also more efficiently.
(By Sandeep Bhardwaj, Chief Sales Officer, Angel Broking)