What Are Hybrid Mutual Funds?

Posted On Thursday, Jan 23, 2020


Hybrid Funds, as the name suggests, invest in a mix of equity and debt & money market instruments. These funds aim to provide investors with the best of both worlds – capital appreciation of equity assets and the regular income of debt securities.

Broadly, hybrid funds are ideal for investors with a moderate-to-high risk appetite. The risk or volatility of these funds lies in allocation between equity and debt.

Depending on their exposure to equity, these funds can be further classified into Conservative Hybrid Funds, Aggressive Hybrid Funds, Balanced Funds, Dynamic Funds, etc.

The capital market regulator has sub-categorised hybrid funds into 6 types:

1) Conservative Hybrid Fund – Such a scheme is mandated to invest between 10% to 25% of total assets in equity & equity related instruments, and the remaining 75-90% of the total assets in debt instruments. Owing to the dominant allocation to debt instruments, it is termed as a conservative hybrid fund. It is expected to follow a distinctive strategy for the equity portfolio and debt portfolio.

Suitability: If you are conservative or do not have the stomach for high risk, at the same time wish to have some exposure to equity & equity related instruments to yield a better return, you could consider a conservative hybrid fund.

2) Balanced hybrid/Aggressive Hybrid Fund – A balanced hybrid fund invests 40% to 60% of total assets in equities and 40% to 60% in debt instruments. No arbitrage is permitted in this scheme. Tactically, from an asset allocation standpoint, the portfolio is well-balanced between equity and debt instruments. Clearly, a balanced hybrid fund does not qualify as equity funds. But they stand true to their name, by keeping a balanced exposure to equity and debt.

An aggressive fund, on the other hand, invests 65% to 80% of total assets in equities and 20% to 35% in debt instruments. Therefore, on account of the portfolio being skewed to equities, they are termed as ‘aggressive’.

Suitability: If you wish to have almost an equal balance to both equity and debt, are a moderate- to-high risk-taker; a balanced hybrid fund would be an appropriate choice, provided your investment time horizon is at least 5 years.

However, if you wish to have a slightly higher exposure to equity, an aggressive hybrid fund would be appropriate. But again your investment time horizon ought to be at least 5 years.

3) Dynamic Asset Allocation Fund or Balanced Advantage Fund – The allocation to equity and debt is managed dynamically by such a fund. So, it can hold 0 to 100% in equity or 0% to 100% in debt. There is no restriction on minimum or maximum exposure to either equity or debt.

The fund can choose to be fully allocated either to equity or debt instruments depending on the fund manager’s view of the market. Certain dynamic funds have a formula-driven approach that takes into consideration market valuations and other factors. The allocation is pre-decided based on the formula that defines the equity exposure based on the different variables.

Though a Balanced Advantage Fund also set their asset allocation as per the direction of the market, they tend to keep a minimum 65% exposure to equity at all times.

Suitability:The risk a dynamic asset allocation fund would expose you to would depend on its exposure to equity and debt over a period of time. For a dynamic exposure to equity and debt, a dynamic asset allocation fund may be suitable provided your investment time horizon is at least 5 years and willing to assume moderate-to-high risk.

However, if the fund holds the portfolio in the nature of a balanced advantage fund (i.e. keep a minimum 65% exposure to equity at all times),then the risk-reward potential would be similar to that of an aggressive hybrid fund.

4) Multi-asset Allocation Fund Such a fund invests in at least three asset classes (mainly equity, debt, and gold) with a minimum allocation of at least 10% each in all three asset classes.

The basic purpose of investing in multi-asset allocation fund is to diversify investments in assets classes that share very low positive correlation. Lower positive correlation between two asset classes indicates that they are unlikely to move in the same direction.

While debt is considered safer than equities; equities can generate superior returns. And including gold would improve the diversification of your portfolio. Suitability: If you are aiming to tactically diversify your portfolio with a single fund, leave rebalancing to the discretion and expertise of the fund manager, and lower risk, you may consider multi-asset fund with an investment time horizon of 3 to 5 years.

5) Equity Savings Fund – Such a fund is mandated to invest minimum 65% in equity & equity related instruments and a minimum of 10% in debt instruments. The schemes minimum hedged & unhedged is to be stated in the SID, while its asset allocation under defensive considerations may also be stated in the Offer Document.

To put it simply, an equity savings fund could invest in equity and equity related instruments (including derivatives), debt & money market instruments, and could explore arbitrage opportunities. If there are no arbitrage opportunities available, the fund has the flexibility to invest in debt.

Suitability: From a risk-return standpoint, given that it skews the portfolios to equity & equity related instruments, an equity savings fund is a high risk-high return investment proposition. So, consider only if you have the stomach for high risk and an investment time horizon of at least 5 years.

6) Arbitrage Fund – This category of mutual fund endeavours to take advantage of mispricing of stocks (or a stock index) in different market segments, known as arbitrage. However, these are short-term opportunities that spring up due to lack of information to a set of market participants in one of the markets.

An arbitrage fund is mandated to follow arbitrage strategy and invest minimum 65% of its total assets in equity & equity related instruments. Since the transactions are in either direction, the positions are completely hedged.

Suitability: Arbitrage transactions are virtually risk-free. Hence an arbitrage fund carries low risk and the returns you can expect could be in the range of 6%-7% p.a. – depending on the market conditions and fund manager’s ability to reap rewards from arbitrage opportunities. To park money for the short-term, you may consider an arbitrage fund.

Disclaimer, Statutory Details & Risk Factors:

The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.

Above article is authored by Quantum.

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