What are Hybrid Funds?
Mutual funds that invest in more than one asset class are called hybrid funds. Usually, they combine equity and debt assets, but they can also invest in gold and real estate.
A hybrid fund’s three core philosophies are asset allocation, correlation, and diversification. An asset allocation strategy involves distributing wealth among various asset classes. In contrast, a correlation strategy consists of the co-movement of returns between assets, and a diversification strategy diversifies a portfolio by including more than one asset.
A high correlation in returns is typically observed between investment options within an asset class since the sources of risk and factors affecting returns are similar. In contrast, investment options across asset classes exhibit little correlation in returns.
By combining assets with low correlations, portfolio risk can be reduced. Hybrid mutual funds invest in multiple asset classes to achieve maximum returns at the least risk. A fund manager decides which asset classes to allocate based on the fund’s investment objective and the current market conditions.
Types of Hybrid Funds
Hybrid funds are further categorized based on asset allocation. While some hybrid funds have a higher equity allocation, others lean more towards debt. Let’s have a look in detail:
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Equity Oriented Hybrid Funds:
It is called an equity-oriented hybrid fund if the fund manager invests more than 65% of its assets in equity and the rest in debt and money markets. Equity shares of companies in industries such as FMCG, finance, healthcare, real estate, automobiles, etc. make up the fund’s equity component.
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Debt-oriented balanced funds:
When the fund manager allocates more than 65% of its assets to debt instruments, it is considered a debt-oriented fund. Its debt component comprises fixed-income investments such as government securities, debentures, bonds, treasuries, etc. To maintain liquidity, some of the funds will also be invested in cash and cash equivalents.
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Monthly Income Plans:
MIPs are a great way to get regular income and generate higher returns than debt funds. With 15-20% exposure to equities, MIPs allows investors to choose the frequency of dividends payout. Whether monthly, quarterly, half-yearly, or annual, MIPs are a great way to get the most out of your investment.
MIPs offer the growth option, which allows the investments to grow in the fund’s corpus. They are not simply small monthly income investments. Instead, they are hybrid funds that invest primarily in debt and some equities. Do not let the name mislead you – MIPs can be an excellent option for diversifying your portfolio.
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Arbitrage Funds:
An arbitrage fund manager attempts to maximize returns by purchasing a stock at a lower price in one market over another. He then resells it in another market for a greater price. However, such opportunities are not always available. In the absence of opportunities for arbitrage funds, they may opt for debt or cash. Like other debt funds, Arbitrage funds are designed to be reasonably secure. However, its long-term capital gains are taxed, just like any other equity fund.
Benefits of Investing in Hybrid Fund
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You can access multiple asset classes with a single fund:
With a hybrid mutual fund, you can get exposure to multiple asset classes in a single product. This is much better over investing in different funds for each asset class, as it can save you time and money.
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Active Risk Management:
A hybrid mutual fund is an investment vehicle that combines different asset classes to provide active risk management. This type of fund seeks to mitigate risk by diversifying its holdings across non-correlated asset classes, such as equity and debt.
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Diversification:
Diversification is vital for investing, and hybrid funds offer the perfect solution. By investing in various asset classes and sub-classes, you can minimize risk while still achieving your financial goals. Whether you’re looking for large-cap, mid-cap, or small-cap stocks, value, or growth stocks, hybrid funds have you covered.
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Caters to various risk profiles:
There are many different types of hybrid funds available, each offering an extra level of risk tolerance. There are equity-oriented schemes for those who are willing to take on more risk, while those who want to minimize risk have debt-oriented schemes.
There is the Dynamic Asset Allocation Fund for investors who want the flexibility to adjust their asset allocation based on market conditions without having to make the decisions themselves. And for those looking for stability in a volatile environment, there is arbitrage.
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Buying low and selling high:
The asset managers of hybrid funds constantly monitor the portfolio’s asset allocation and make necessary adjustments to keep it within the permissible limit. This may involve selling an asset class when it is high and buying when it is low.
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Automatic Rebalancing:
The fund manager of hybrid funds constantly rebalances the portfolio, so the investor doesn’t have to worry about it. This saves them time and effort that would otherwise be spent tracking the markets and managing asset allocation.
How is a hybrid fund different from a balanced fund?
Most hybrid funds invest in a mixture of debt and equity in varying proportions. These include debt/fixed-deposit securities, equity, and commodities.
Balanced funds invest the same amount in stocks and FDs. These funds provide a balanced portfolio that combines both growth and stability.
How to Find the Best Hybrid Fund?
Investors often wonder how to choose the best hybrid fund. Many factors go into this decision, including the fund’s consistency in return, the quality of its management team, the size of its corpus, and its risk and expense ratios.
However, one must also consider how the fund has performed compared to its peers over time. A good hybrid fund should consistently rank in the top 25% of its peer group. It’s essential to look at the risk that the fund has taken to achieve those returns.
When looking at investment options, it is essential to consider the launch date to get a sense of the fund’s history and how it has performed over time. Additionally, best hybrid funds usually have a reasonable corpus size; not too small that there isn’t enough attention given to it, and not too large that it becomes difficult to manage.
Another important factor to consider is an experienced fund management team with a good research base and market knowledge.
Final Word
A hybrid mutual fund invests in more than one asset class, generally a combination of equity and debt funds, and sometimes gold funds.
The primary goal of hybrid funds is to generate capital appreciation through equity allocation while reducing volatility through the debt component of the portfolio. This is achieved by diversifying the fund’s assets among different asset classifications.
The risk tolerance level of hybrid funds ranges from conservative to to aggressive. They are a good entry point for new investors in the equity market who want to build wealth for long-term goals.
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