Hybrid mutual funds are types of mutual funds that invest in more than one asset class. Most often, they are a combination of Equity and Debt assets, and sometimes they also include Gold or even Real estate.
The key philosophies behind hybrid funds are – asset allocation, correlation, and diversification. Asset Allocation is the process of deciding how to distribute wealth among various asset classes, and correlation is the co-movement of returns of the assets, and diversification is to have more than one asset in a portfolio.
Since the sources of risk and factors affecting returns are similar for the investment options within an asset class, they tend to exhibit a high level of correlation in returns, whereas investment options across asset classes show little correlation in returns.
Types of hybrid mutual funds
Balanced Hybrid Funds- These schemes invest a minimum of 40 and a maximum of 60% in both equity and debt asset classes. The objective is to generate long term capital generation through investment in the equity asset class and balance the risk through debt allocation. Arbitrage is not permitted in this category of schemes.
Debt-oriented hybrid funds- These funds invest at least 60% of their assets in debt instruments like bonds, debentures, and government securities.
Balanced hybrid funds- This fund balances the equity and debt portion of your investment and invests a minimum of 40% and a maximum of 60% in either of the asset classes. A benefit of investing in a balanced fund is that it uses equity and debt components to leverage current market scenarios to generate wealth in the long term.
Multi Asset Allocation Fund- These schemes need to have investments in at least three asset classes with a minimum of at least 10 %in each of the asset classes. These funds give the investors the exposure to investing in more asset classes, and based on the view of the fund manager, the asset allocation is decided.
Arbitrage Fund- Arbitrage strategy is buying in the cash market and the simultaneous selling in the futures market to generate returns through the price differential between both markets. This is done through derivative instruments, which are categorized as equity-oriented instruments. Since there is a simultaneous buy and sell, there is no directional call on the stock and hence does not carry the volatility of the equity asset class and generates a stable debt-like return. These schemes invest 65 to 100% in equity assets and 0 to 35%in debt asset classes. This fund is suitable for low-risk investors who want to generate debt like returns with equity taxation in a high volatility period.
Things to Consider Before Investing in Hybrid Funds
Time Horizon: Hybrid funds are suited for a medium-term time horizon say from 3-5 years. The longer the time horizon, the better the chances of getting stable, higher returns.
Cost: Like any other mutual funds, hybrid funds also charge a fee known as the expense ratio. The lower the expense ratio, the better for the investor. Although a high expense ratio impacts the fund returns, it is not necessary that the high expense ratio will always give low returns.
Returns: Hybrid Funds don’t offer guaranteed returns. Their returns are affected by the performance of the underlying investments. The equity market performance will affect the returns to the tune of equity exposure of the fund. The returns of an aggressive oriented hybrid fund will be more correlated with the equity markets as compared to the balanced and conservative-oriented hybrid fund. In a rising market, its performance lags the funds with 100% equity allocation, and in a falling market, it will outperform pure equity funds.
Risk: Investment in hybrid funds is not devoid of risk. The risk in a hybrid fund primarily depends upon the proportion of equity holding in the portfolio. The higher the equity component, the riskier the fund. The segment of the equity market in which the fund invests and the strategy used will define the risk of the equity component. In the case of debt-oriented funds, risk will be defined by whether the debt portion is managed for interest income or capital gains.
Diversification: They diversify the portfolio not only across asset classes but also across sub-classes within the asset class. Like within the overall Equity allocation, they invest in large cap, mid cap, or small cap stocks, value, or growth stocks.
Access multiple asset classes with a single fund: One of the clear advantages of hybrid mutual funds is that instead of investing in different funds to meet the need for different asset classes, an investor can access multiple asset classes in a single product.
Buying low and selling high: The fund managers rebalance the portfolio to adjust the asset allocation within the permissible limit leading to selling a particular asset class when high and buying when low.
Active Risk Management: Hybrid mutual fund provides active risk management through portfolio diversification and asset allocation. They manage risk by combining non-correlated asset classes like equity and debt.
How to Find the Best Hybrid Fund
Hybrid funds are evaluated on the basis of consistency in return, fund management team, vintage, corpus, risk, return, and expense ratio. Best hybrid funds are those which consistently lie in the top 25% of their peer group over a period of time. However, it is important to see the risk that they have taken to achieve those returns.
It is also important to look at the launch date to understand the period of existence and performance across the period. Best hybrid funds also have a reasonable corpus size. Not too small that there is not enough attention given and not too large that it becomes difficult to manage.
Hybrid mutual funds are types of mutual funds that invest in more than one asset class typically a combination of Equity and Debt assets, and sometimes they also include Gold.
Hybrid funds offer varying levels of risk tolerance ranging from conservative to moderate and aggressive. The key philosophies behind hybrid funds are asset allocation and diversification.
They aim to generate capital appreciation through equity allocation and to reduce the volatility through the debt component of the portfolio. They serve as a good entry point for new investors in the equity market, also can be used for saving for any specific medium-term goal.