How to pick the right Hybrid Fund?

Within the vast universe of investments, we are often perplexed when it comes to picking the right instruments when we have limited money to invest. Even if you choose to invest only in mutual funds, you may be spoilt for choices given the number of options available based on asset class, market cap, and so on. But what if a single mutual fund gave you exposure to more than one asset class? Well, hybrid mutual funds do exactly that!

A hybrid mutual fund is a type of mutual fund that typically invests in a combination of various assets such as equity, debt, gold, among others. Usually, equity and debt account for the two largest exposures in a hybrid scheme depending on its . This allows you to reap the benefits of any upside resulting from equity exposure and limits the downside via the fixed income or debt exposure while gold allows you to hedge any risk arising from inflation or other market risks.

Hybrid funds seek to create a balanced portfolio and can be classified into five major categories:

Conservative Hybrid Funds: Conservative hybrid funds primarily invest in debt instruments. The equity allocation for these funds can be anywhere between 10% to 25%, while the debt allocation ranges from 75% to 90%.

Balanced Hybrid Funds: Balanced hybrid funds generally invest 40% to 60% of their assets in equities and the rest in debt. Such funds seek to strike a sound balance between risk and reward.

Aggressive Hybrid Funds: Aggressive hybrid funds allocated 65% to 80% of the total assets to equity and equity-related securities. These funds are riskier in nature compared to other hybrid categories, given the dominant share of equities.

Dynamic Asset Allocation Funds: Dynamic asset allocation funds offer the flexibility of exposure across debt and equity with no limits fixed by SEBI. As the name suggests, the allocation between equity and debt is managed dynamically depending on market conditions.

Multi-Asset Allocation Funds: Multi-asset allocation funds invest in at least three asset classes with a minimum allocation of 10% per asset class. These funds usually are a mix of equity, debt, and an additional asset class such as gold or real estate. These funds are an attractive option for those seeking diversification.

Key factors to consider when picking a hybrid fund:

Level of Equity exposure: While selecting a hybrid fund, it is essential to know the equity exposure of the fund. Given that equity comes with higher risk than most fixed income securities, you would need to assess your risk preference, and pick only those funds whose risk levels are in line with your risk appetite. For instance, if you wish to take greater risk, you can opt for the aggressive hybrid fund category. On the other hand, if the safety of your capital is a priority for you, you may want to go for conservative hybrid funds.

Investment horizon: Another factor to consider while selecting a hybrid mutual fund is your investment horizon. For a longer investment horizon, you may consider investing in equity-dominated hybrid funds. However, if you have a short investment horizon in mind, it is better to go with a debt-dominated hybrid fund.

Taxation: The taxes applicable on returns from a hybrid fund depend on its asset allocation. If a hybrid fund’s equity exposure exceeds 65%, it is taxed like an equity fund. If the fund is debt-oriented, then taxation rules of debt funds apply. This can also have a significant difference on your post-tax returns.

It is important to note that tax on debt funds is levied on long term capital gains received on investments held for over three years. Such investments also get the benefit of indexation. For equity, a 10% long-term capital gains tax is applicable on investments held for over one year where the gains made exceed Rs 1 lakh. However, to get the most benefit out of equity investments it is advisable to hold them for a period of at least 3-5 years.

In conclusion, hybrid funds can be a valuable addition to your portfolio, particularly, if you are seeking to investing in both equity and debt securities and wish to avoid multiple products. Among the various categories of hybrid funds available, the easiest way to pick a hybrid fund that is right for you is to assess your risk preference, investment horizon, and taxation aspects of the fund under consideration.

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