Hybrid funds are excellent investment funds for those looking to achieve both high returns and capital protection. With hybrid funds, you can balance your asset allocation while minimizing the risk in your portfolio.
Like any other financial instrument, learning how hybrid funds work, their types, and benefits is always essential.
Hybrid Fund Explained
As the name suggests, a hybrid fund is a mutual fund that invests in more than one asset category. Mutual funds mainly invest in stocks and bonds, while hybrid funds invest in equities and debt funds.
That way, the investor has capital protection as some of his investments are in debt funds, while the rest of his finances are invested stocks, providing him the potential to yield better returns.
The allocation of debt and stock is usually determined according to the trader’s risk appetite, financial goals, and investment horizon.
In a nutshell, a hybrid fund offers the opportunity to generate higher returns when compared to debt funds, but it is less risky than funds mainly focused on equities. A hybrid fund is able to diversify a portfolio while minimizing risks.
Types of Hybrid Funds
Hybrid funds are classified based on their asset allocation into the following types:
Equity-oriented Hybrid Funds
These are hybrid funds that invest over 65% of their assets in equity, while the remaining portion invests in money market instruments and debt securities. The equity part of the fund can be invested in small-cap, mid-cap, and large-cap firms across different industries or a specific sector.
Debt-oriented Hybrid Funds
Debt-oriented hybrid funds invest more than 65% of their assets in debt instruments, such as government securities, debentures, and corporate bonds. The equity portion in this fund is less than the debt portion, which makes it less risky.
Monthly Income Plans
A monthly income plan (MIP) focuses on generating a steady profit through dividends and ensuring capital protection. While it is called a monthly income plan, not all MIP funds offer dividend payouts every month.
It is up to the investor to decide whether he wants to receive the payout monthly, quarterly, semi-annually, or annually. MIPs often limit the equity exposure from around 15% to 20%, while the rest of the investments are in debt funds.
Some MIPs can also offer growth options, which reinvest the dividends and help the fund increase its corpus.
Arbitrage Funds
In an arbitrage fund, the fund manager helps maximize the returns by investing in stocks bought for a lower price. The fund manager then profits by selling the purchased share in another market.
However, arbitrage opportunities are not often and are only available for a short time. If there are no opportunities, arbitrage funds will invest in debt instruments and cash. Moreover, the long-term profit from these funds is also taxable, like the profits from equity funds.
Still, arbitrage funds are a low-risk strategy since the buy and sell transaction is carried out simultaneously, allowing the gains or losses to be locked in right away. That keeps the equity’s volatility in check and provides more stable returns similar to debts.
Balanced Fund
A balanced hybrid fund is another low-risk investment with excellent capital appreciation. This fund invests in debt and equity in a specific percentage. The equity allocation is usually at 40% to 60%, while the rest is in debts or vice versa.
Benefits to Investing in Hybrid Funds
Balances Risk with Returns
Hybrid funds allow traders to achieve a proper balance between risk and returns. They offer debt-like stability when compared to pure equity funds. Moreover, hybrid funds enable investors to try investing in high-return equities by minimizing the associated risk using the expected returns on their debts.
Diversification
A hybrid fund aims to balance the asset mix of multiple classes with the goal of diversifying the portfolio. This fund spreads the risks by investing in both equity and debt.
As a result, traders’ risk exposure to any single asset class is reduced, as the debt instruments’ returns will offset the equities’ fluctuations. A mixed-asset allocation also spreads the risks further by putting it in other markets such as commodities.
Low Volatility
Hybrid funds can provide investors the flexibility they need to manage volatility. For example, the immediate sale through an arbitrage fund ensures that volatility will not affect your returns.
What You Need to Consider Before Investing
Hybrids Funds are Not Risk-free
Hybrids are not as risky as equity funds, but that doesn’t make them completely free of risk. Keep in mind that hybrid funds partly consist of equity investments that carry market risks. Always practice caution and select a hybrid fund that fits your risk profile.
Returns are Not 100% Guaranteed
How hybrid funds will perform will depend on the value of the primary securities. If they perform well, the fund’s net asset value (NAV) climbs. If they perform poorly, the fund’s NAV declines.
Note that market fluctuations can influence the performance of hybrid funds, which, in turn, can impact your returns.
There is an Expense Ratio
Hybrid funds entail a fee like other mutual funds. That cost is called the expense ratio, which a fund firm charges for managing your portfolio.
Therefore, if you plan to invest in a hybrid fund, make sure to compare similar funds and pick the one that has a lower expense ratio. The lower the fee, the higher the returns will be for you.
Investment Horizon
Traders looking to invest in hybrid funds for five years or more can do so. These funds are ideal for investors who want to earn to achieve important financial goals such as buying a car and paying for school, among others.
In addition, retirees seeking a boost on their post-retirement income can find just that in hybrid funds that offer dividend payouts.
There is Interest Tax
Capital gains tax is a vital part of learning about hybrid funds. How these funds are taxed will depend on the equity exposure. If it goes beyond 65%, the equity aspect of the hybrid fund will be taxed like other equity funds; otherwise, it would be taxed like a debt fund.
