What are Hybrid Funds? Types & Benefits of Hybrid Funds

We here in India have numerous investment options to choose from. That’s because the Indian investment market has a plethora of financial products to choose from. But the problem is that a lot of people lack investment knowledge and this is why they usually end up investing in financial vehicles without having much idea about the same. This is as good as gambling with your money and hoping that the scheme you invested in will give you good capital appreciation. This type of investing is unhealthy and might lead one to bankruptcy. So it is better that you take your time and try to understand the various aspects of the scheme. Investing is a long journey and if you really want to stand a chance of benefiting, you may have to remain invested for the long run.

A lot of individuals feel that once they invest their money, they should be able to get returns within one or two years. This is impossible in most cases and if you really want to watch your investments grow, you may have to be far more patient than that. Individuals who are good at money management often excel in financial planning. If you want to give your investments a strategic approach you may have to be effective at financial planning. The reason money management is important because it teaches you to control your outflows. Preparing a budget and making sure that you take care of all your monthly expenditures without exceeding the budget is necessary. Only when you learn to save from your regular earnings, you will have some capital in hand to make the initial investment.

The power of financial planning is known by those who religiously practice it. Especially during pandemics and emergencies, when all the income sources come to a standstill, money saved through financial planning acts as an emergency fund. The first step of financial planning is understanding your short term and long term financial goals. Financial goals can vary from one individual to another. It is better that you prioritize your goals so that you can look out for schemes accordingly. You may want to build a retirement corpus worth Rs. 25 lakhs to Rs. 30 lakhs or must be looking to save enough to secure your child’s future. These are long term financial goals that need a long investment horizon of at least 20 years. People should understand that if they want to build such a huge amount, they may have to invest regularly and remain committed to their investments. A lot of times, due to some reason, people always end up withdrawing their investments before time, thus not succeeding in meeting their goals.

Short term goals too may vary from one individual to another. You might be wanting to save enough so that you can buy that car you always wanted. On the other hand, someone else might be looking forward to renovating their home and hence looking to build a short term corpus. Just like every individual has different financial goals, every person’s risk appetite varies depending on their income, age, monthly expenditures and existing liabilities. Every scheme carries a different risk profile, so before you go ahead and invest make sure that your risk appetite and investment objective aligns with that of the scheme. There are some schemes that offer low fixed income rates and are relatively less risky. However, one can never consider any investment scheme to be entirely risk free. There is always some risk associated with every investment.

If you are someone who is keen on building a corpus and has a long term investment horizon, you may consider investing in mutual funds.

What are mutual funds?

Mutual funds are professionally managed funds where fund houses / asset management companies collect money from investors sharing a common investment objective and invest this pool of funds across the Indian economy. This collective pool of funds is invested in various assets like equity, debt, call money, certificate of deposits, corporate bonds, government securities, etc.

SEBI, the regulator of mutual funds in India, define them as, “a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in the offer document.

Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with the quantum of money invested by them. Investors of mutual funds are known as unitholders.

The profits or losses are shared by the investors in proportion to their investments. The mutual funds normally come out with a number of schemes with different investment objectives which are launched from time to time. A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI) which regulates securities markets before it can collect funds from the public.”

Types of mutual funds

Mutual funds are further categorized by SEBI so that investors get a clear picture about each mutual fund scheme and its investment objective, risk profile, asset allocation and other such attributes. Since there are various schemes available, investors are spoilt for choice. But they should not make the mistake of investing in a scheme that is beyond their risk appetite.

Here are some of the major mutual fund categories:

Equity funds: Equity funds are those mutual funds that invest predominantly in equity and equity related instruments among other asset classes.

Debt funds: Debt mutual funds invest in fixed income securities like call money, treasury bills, government securities, certificate of deposits, commercial papers, etc.

Solution oriented funds: Solution oriented funds are those mutual funds that aim to provide investors with a solution to their financial needs. Some of the examples of solutions oriented funds are retirement funds and children’s funds.

Index Funds: According to SEBI, an index fund “replicates the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc. These schemes invest in the securities in the same weightage comprising an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as "tracking error" in technical terms.”

Hybrid funds: While index funds predominantly invest in equity and equity related instruments and debt funds invest in fixed income securities and other debt instruments, hybrid funds invest in both equity and debt related instruments. This is why they are also called balanced funds.

Today we are going to focus on hybrid funds, what schemes come under hybrid funds and some of the benefits of hybrid funds.

What are hybrid funds and what are its types?

Like mentioned earlier, hybrid funds are a mix and match of equity and debt related instruments. The proportion in which a hybrid fund will invest in equity or debt may solely depend on the investment objective and nature of the scheme. Investors who wish to not expose their finances entirely to equity and are looking for a balance between equity and debt generally consider investing in debt funds.

As per SEBI’s circular dated October 2017, there are seven categories under hybrid schemes:

1. Conservative Hybrid Fund: As per SEBI guidelines, a conservative hybrid fund must invest 10 to 25 per cent of total assets in equity and equity related instruments between whereas, 75 to 90 per cent of total assets in debt instruments. It is an open ended hybrid scheme which invests predominantly in debt instruments. It also allots some of its assets to equity related securities as mentioned above.

2. Balanced Hybrid Fund: According to SEBI, a balanced fund must invest 40 per cent to 60 percent of the total assets in equity and equity related instruments as well as in debt instruments. This makes a balanced fund an open ended scheme that invests in equity and debt related instruments.

3. Aggressive Hybrid Fund: Of its total assets, an aggressive hybrid fund must invest 65 percent to 80 percent of total in equity and equity related instruments whereas 20 percent to 35 percent of the total assets in debt instruments.

4. Dynamic Asset Allocation Fund: Dynamic Asset Allocation Fund is a hybrid fund that manages its equity and debt instruments dynamically. This fund generally follows an investment strategy where the fund manager invests less when the markets are down and more when the markets are low.

5. Multi Asset Allocation Fund: This fund invests in a minimum of three asset classes with a minimum allocation of 10 percent in each asset class.

6. Arbitrage Fund: This hybrid fund must follow an arbitrage strategy where a minimum of 65 percent to the total assets must be made in investment in equity and equity related instruments.

7. Equity Savings Fund: An equity savings fund must invest a minimum 65 percent of total assets in equity and equity related instruments and a minimum of 10 percent of the total assets in debt.

Benefits of investing in hybrid funds

Here are some of the reasons why investing in hybrid funds may prove to be beneficial:

Unique asset allocation: By now you know that hybrid funds invest in debt and equity. But the proportions are never fixed and may differ from one hybrid scheme to another. For example, an aggressive hybrid fund may allocate a higher proportion of assets in equity and one the contrary, a more conservative hybrid fund may invest a major proportion of assets in debt and debt related instruments. This is good for investors as someone with an aggressive investment approach may opt for a hybrid fund that is more equity oriented and a conservative investor may opt for a hybrid fund that invests majorly in debt instruments.

Meeting financial goals: Hybrid funds may be considered by investors to meet their financial goals. However, people should not solely depend on hybrid funds to fulfill their goals and they may diversify their financial portfolio with other investment schemes.

Long term investment: Since hybrid schemes invest in equity related instruments, someone with a long term investment horizon may find these schemes beneficial. That’s because equity oriented investments generally tend to perform when held for a longer period of time. Hence one may consider investing in hybrid funds for meeting long term financial goals.

Hybrid funds offer SIP investment: You can either make a lumpsum payment while investing in hybrid funds or you may opt for SIP to give your hybrid fund a systematic approach. Systematic Investment Plan (SIP), is an easy and hassle free way for regular investing. With SIP, all one needs to do is instruct their bank and every month on a predetermined date a fixed amount is debited from your savings account and electronically transferred to the hybrid fund. SIPs are generally good for someone who wants to give their investments a disciplinary approach. You may continue investing in the hybrid fund via SIP till your investment objective is achieved.

Now that you are aware about hybrid funds and some of the benefits of investing in hybrid funds, plan on investing? But before you go ahead and make the actual investment make sure that you are clear about your investment goals and do not have any existing liabilities that may affect your investments in future. Individuals should be consistent with their mutual fund investments if they want to earn some capital gains. Also, one may have to do some basic research about the fund before investing. Do check for the fund’s track record, find out whether the hybrid fund has been a consistent performer in the past. You may also look at other aspects like the fund’s expense ratio, risk profile, to get a clearer picture. Lastly, if you are someone who is completely new to mutual fund investments or financial planning in general, make sure that you go ahead and consult a financial advisor.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.