Hybrid Funds - Risk, Returns and the way between

Equity gives high returns but has a higher risk, too. On the other hand, debt is safe, but the returns are something to worry about.

This is a common dilemma most investors face, whether for higher returns or a safer investment. The definition of a safe investment and a high return varies from investor to investor, but equity funds usually entail a high return for an average investor. In contrast, debt funds sound synonymous with a safe investment. Coming back to the dilemma, does there exist a way to ensure the investment attains a good return while giving peace of mind?

This blog is all about that same way of investing, i.e., Hybrid Funds.

Hybrid Funds

As the name suggests, a hybrid is composed of two or more entities so that the best of the qualities get taught in the newly formed entity. Similarly, hybrid funds are managed by equity, debt, a proportion of cash and sometimes even other mutual funds in various ratios.

How do these funds work?

The managers of these funds vary the proportion of equity and debt in the investment portfolio to achieve the fund's objective. The fund manager may also keep a portion of the portfolio in cash to take advantage of any market movement depending on the hybrid fund chosen.

Types of Hybrid Funds

Hybrid funds can be further classified based on portfolio allocation and their objective.

Equity Oriented Hybrid Funds

These funds invest more than 65% of the portfolio in equity and the rest in debt and cash instruments. The equity component of this fund consists of various stocks and equity-based mutual funds.

Debt Oriented Hybrid Funds

On the other hand, if a fund invests more than 65% of the assets in debt instruments like government bonds, debentures, treasury bills and even commodities like gold. Some portions of assets are kept in the form of cash for liquidity.

Monthly Income Plans

These mutual funds invest a more significant proportion of assets in debt, while the fund's equity portion remains restricted to a small proportion. They allow investors to gain a greater return than ordinary debt funds while providing a regular income in terms of dividends. The investors can choose the frequency of payouts.

Arbitrage Funds

These funds hold a more significant proportion of assets in cash. The fund managers buy assets at a lower price in one market and sell them at a higher price. This practice is known as arbitrage. They might hold some proportion of assets in debt while the equity portion remains negligible.

Who should invest in hybrid funds?

As mentioned in many earlier blogs, it is never wise to suggest a one size fits all strategy for investment. However, one can judge whether an investment instrument is meant for them by comparing the pros and cons of an investment.

Benefits of Hybrid Funds

• Lowers the risk - These funds are best suited for the investors willing to take a bit more trouble than a debt fund or a fixed income instrument like debentures, bonds etc. but are hesitant to rely their money on markets.
• Uses market movement - A subcategory of these funds, i.e., arbitrage funds, uses market movement to generate risk-free returns by using the difference in the price of an asset in different markets.

Things to consider

• Lower returns - These funds offer a considerably lower return than equity funds due to the presence of a significant debt component.
• Expense Ratio - Since the funds offer a very competitive rate of returns, the investor must do a comparative analysis to choose the fund that charges the lowest expense ratio, thus ensuring a higher actual return.
• Taxation - The fund's composition decides what portion of the pie goes to the government. The funds with greater than 65% exposure to equity, cash or a combination of both are taxed like equity funds, while the ones are falling short of 65% share the pie as the debt funds do.
• Investment Horizon - It is important to define one's investment horizon before investing in these funds. The tax implications vary widely according to the composition and the time the funds are held.

A long, long blog indeed. Let us leave you with an analysis of a hybrid fund Spenny offers on its platform.

Aditya Birla Sun Life Balanced Advantage Fund-Growth (or as we call the octopus)

We'll be back with another blog. Till then, Stay Safe! Invest Safer!

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