Investing in mutual funds offers a variety of options to suit different financial goals and risk appetites. Hybrid mutual funds stand out as they blend various asset classes like equity, debt, derivatives, and sometimes even gold into one investment product. This combination aims to provide a balanced approach to risk and return, catering to a broad spectrum of investors. This blog will explore the various types of hybrid mutual funds, each offering a unique asset allocation strategy.
What Are Hybrid Mutual Funds?
Hybrid mutual funds are investment products that mix multiple asset classes—typically equity, debt, and derivatives—to create a balanced portfolio. These funds offer investors the convenience of a pre-designed asset mix, eliminating the need to allocate their investments individually. Hybrid mutual funds can be a great option for those who want diversified exposure without the hassle of managing multiple investments.
There are two primary approaches to asset allocation in hybrid funds:
- Formula-Based Allocation: Here, the asset mix follows a pre-determined formula, balancing the proportions of equity, debt, and other assets.
- Discretionary Allocation: In this approach, also known as dynamic funds, the fund manager can adjust the asset allocation based on market conditions.
Types of Hybrid Mutual Funds
The Securities and Exchange Board of India (SEBI) has classified hybrid mutual funds into seven categories, each with distinct characteristics. Let’s take a closer look at these types of hybrid funds in mutual funds.
1. Balanced Hybrid Funds
These funds aim to maintain a nearly equal allocation between equity and debt. Typically, these funds hold between 40% to 60% of their portfolio in equity, with the remainder in debt. This balanced approach seeks to provide long-term capital appreciation from equity while mitigating risk through debt investments.
2. Arbitrage Funds
Arbitrage Funds are unique in that they capitalize on price differences between the equity and futures markets. These funds buy stocks in the equity market and sell equivalent futures contracts, locking in a profit from the price difference. Because a significant portion of the portfolio is held in equities, arbitrage funds are classified as equity funds for tax purposes.
3. Equity Savings Funds
Equity Savings Funds combine equity, debt, and derivatives, similar to arbitrage funds. Still, with a key difference—they are not solely treasury products. These funds use derivatives to enhance returns and are also classified as equity funds for tax purposes. Despite having a total AUM (Assets Under Management) of ₹17,000 crore, equity savings funds have not yet gained widespread popularity as standalone investment options in India.
4. Conservative Hybrid Funds
These funds focus primarily on debt, with 75% to 90% of the portfolio invested in fixed-income securities. The remaining 10% to 25% is allocated to equities, providing some potential for higher returns. These funds are considered conservative because they prioritize capital preservation and regular income, making them ideal for risk-averse investors. However, with a total AUM of ₹20,000 crore, conservative hybrid funds are still emerging as a popular investment choice in India.
5. Aggressive Hybrid Funds
These funds are the opposite of conservative hybrids, with 65% to 80% of their portfolio invested in equities and the remainder in debt. This aggressive allocation aims to achieve higher returns, but it also comes with increased risk. Due to their potential for better returns, aggressive hybrid funds have become popular among Indian investors, with a total AUM of ₹1,50,000 crore.
6. Multi-Asset Allocation Funds
These Funds offer diversification by investing in a minimum of three different asset classes, such as debt, equity, and gold. Each asset class must constitute at least 10% of the portfolio. While these funds provide excellent risk diversification, they are not very common in India, with a total AUM of ₹19,500 crore. The relatively low popularity may be due to the less favourable tax treatment compared to other hybrid funds.
7. Dynamic Asset Allocation Funds
Dynamic Asset Allocation Funds, also known as Balanced Advantage Funds (BAFs), have gained significant popularity in recent years. These funds offer the flexibility to shift their asset allocation between 0% to 100% in equity or debt, depending on market conditions. The fund manager’s discretion plays a crucial role in determining the asset mix, making these funds highly adaptable to changing market dynamics.
Summing Up
Hybrid mutual funds offer diverse investment options, each tailored to different risk profiles and financial goals. Whether you prefer a balanced approach with equity and debt or a more aggressive strategy with higher equity exposure, there is a hybrid fund to suit your needs. Understanding the various types of hybrid funds in mutual funds can help you make informed investment decisions that align with your risk tolerance and long-term objectives.