Hybrid mutual funds are a popular investment choice for those seeking a balanced approach to investing. By including both equity (stocks) and debt securities (such as bonds) in their portfolios, hybrid funds seek to combine the high-risk-reward potential profile of equity with the relative stability of debt funds. This blend class helps investors tap into the growth potential of equities while cushioning against volatility. But with several types of hybrid funds available, it’s essential to understand their nuances to pick the right one for your financial goals.
What are hybrid mutual funds?
Hybrid mutual funds invest in a mix of asset classes, primarily equities and debt securities. The weightage of each asset class in the portfolio varies depending on the type of hybrid fund. They are managed by professional fund managers who strategically allocate assets to optimise returns or balance risk based on market conditions.
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Types of Hybrid Mutual Funds
The Securities and Exchange Board of India (SEBI) classifies hybrid funds into different categories based on their asset allocation and risk profile. Here’s a closer look:
1. Conservative hybrid funds: These fundsinvest predominantly in debt instruments, with a smaller portion allocated to equities. They can invest between 75%-90% in debt and 10%-25% in equities. They can be suitable for risk-averse investors looking for relative stability with slightly higher growth potential than that of pure debt funds.
2. Balanced hybrid funds: Balanced hybrid funds maintain a nearly equal allocation between equity and debt, with both ranging from 40%-60%. They seek to achieve a balanced risk-reward profile, making them suitable for investors looking for moderate growth potential without taking on excessive risk.
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3. Aggressive hybrid funds: Aggressive hybrid funds invest a larger portion in equities (65%-80%) and 20%-35% in debt securities. This makes them high risk but with greater potential for capital appreciation in the long term. Thus, they are suitable for investors with a high risk tolerance and a long investment horizon.
4. Dynamic asset allocation or balanced advantage funds: These funds can dynamically adjust their allocation between equity and debt based on market conditions and the fund manager’s outlook. There’s no fixed allocation, allowing flexibility in response to market volatility. The risk varies depending on the fund’s typical asset allocation, based on its investment strategy. During bull markets, these funds may have a higher equity exposure, while in bear markets, they may shift more towards debt. Such funds are suitable for investors who want a flexible investment avenue that can leverage different market conditions.
5. Multi-asset allocation funds: Multi-asset allocation funds invest in at least three different asset classes, such as equity, debt, and commodities (e.g., gold), with a minimum allocation of 10% or more to each. These too are dynamically managed, meaning that fund managers can freely adjust the portfolio between these asset classes, provided they meet then minimum 10% allocation. This diversified asset allocation helps spread risk across multiple market segments. Moreover, each asset class can offer unique opportunities in different market conditions. Equities give the fund high growth potential, commodities can offer capital appreciation potential and serve as a hedge against volatility, and debt can lend relative stability to the portfolio. These funds are suitable for investors looking for broad diversification and exposure to multiple asset classes without having to manage multiple investments. They can also offer an optimal risk-reward balance.
6. Arbitrage funds: These funds invest in arbitrage opportunities, seeking to benefit from the price difference of a security between two markets or market segments. They must invest at least 65% of their portfolio in arbitrage opportunities and the rest in debt instruments. Despite being equity-heavy, arbitrage funds are low risk, as they exploit temporary inefficiencies and price differences in the market, making simultaneous buy and sell decisions. This makes them suitable for conservative investors or short-term investors seeking an avenue that can offer liquidity as well as better return potential than traditional avenues such as savings accounts.
7. Equity savings funds: Equity savings funds invest in a mix of equities, debt, and arbitrage opportunities. They need to maintain a minimum 65% allocation to equities and arbitrage and 10% in debt.These funds typically entail moderate or moderately high risk, combining equity market exposure with the relative stability of debt and arbitrage investments. This makes them suitable for those seeking a diversified portfolio that balances risk with return potential.
Choosing a hybrid fund
When selecting a hybrid fund, investors should keep their financial goals, risk appetite, and investment horizon in mind. Here are some pointers:
1. Assess your risk appetite: Those witha low risk tolerance may consider conservative hybrid funds or arbitrage funds. Those with a moderate risk appetite that want an even balance between equity exposure and risk mitigation may opt for balanced hybrid funds or equity funds. Those comfortable with higher risk for higher reward potentialcan consider aggressive hybrid funds. For multi asset allocation funds and dynamic asset allocation funds, the risk level will be determined by the typical asset allocation pattern. Those with an equity allocation of above 65% will be high risk.
2. Define your investment horizon: For short-term goals, conservative hybrid funds or arbitrage funds may be suitable. For long term goals, aggressive hybrid funds, dynamic asset allocation funds and multi asset allocation funds can provide the growth potential needed to achieve inflation-beating potential in the long term. Those with a medium investment horizon may consider balanced hybrid funds.
3. Look at other parameters: Consider the fund manager’s expertise, past returns (if available) and risk-adjusted return metrics such as alpha, information ratio and Sharpe ratio to understand the risk-reward balance of the scheme.
Using mutual fund calculators for planning
You can invest in hybrid mutual funds either in lumpsum or through a Systematic Investment Plan (SIP). If lumpsum is your preferred route, you can use a lumpsum mutual fund calculator to help plan your investment. This tool helps you estimate the potential return on your investment based on your principal amount, investment horizon and expected returns. You can experiment with different variations till you arrive at a suitable combination. Similarly, an SIP calculator can help you to plan SIP investments.
Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.