[Mutual Funds] Factors to Consider Before Investing in Hybrid Funds

A hybrid mutual fund helps the investor to earn higher returns than debt fund while minimizing the risk associated with equities.
[Mutual Funds] Factors to Consider Before Investing in Hybrid Funds
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A conservative investor faces double whammy while investing in mutual funds. He wants to avoid the risk associated with equities but at the same time earn higher return through a debt fund. In this case, hybrid funds are an apt solution as they offer a combination of both.

Also Read: Types of Mutual Funds

Why Hybrid Fund?

The investor might not always prefer to be aggressive or conservative; his financial goals might necessitate a fine balance between the two. Hybrid funds offer leverage between equity and debt. A hybrid mutual fund helps the investor to earn higher returns than debt fund while minimizing the risk associated with equities. Hybrid mutual funds primarily invest in asset classes such as equity, debt and gold.

There are a variety of hybrid funds, but equity-oriented hybrid fund, debt-oriented hybrid fund and dynamic hybrid fund are popular among the investors.

Also Read: How to Invest in Mutual Funds

Equity-oriented Hybrid Fund

The hybrid fund investing 65% of the corpus in equity is classified as an equity-oriented hybrid fund. The balance is invested in debt. Hybrid funds are popular because of their ability to generate higher returns than gold and debt funds. Since a major portion of the corpus is invested in equities, this category of hybrid funds is taxed like equity funds. Long-term capital gains (LTCG) above INR 1 lakh are taxed at 10 per cent.

Debt-oriented Hybrid Fund

Debt-oriented hybrid funds invest more than 75% of the corpus in debt instruments, like treasury bills, government bonds etc. An investor can choose to receive regular income by opting for dividend option. These funds are considered to be less risky than their equity counterparts. Debt-orientated funds are ideal for retirees or those approaching retirement. Debt-oriented funds are taxed at 20 per cent with indexation benefit.

Dynamic Hybrid Fund

Unlike equity and debt-oriented funds which face restrictions in asset allocation, a dynamic hybrid fund can invest in equity or debt in any proportion. Dynamic hybrid funds have the flexibility to invest according to market conditions. These funds are ideal instruments for long-term investments. However, if the major portion of the corpus is invested in equity, these funds will be taxed like their equity hybrid fund counterparts.

While hybrid funds are considered safer than a pure equity fund, they still carry a certain risk. The risk depends on assets allocated in the portfolio. Hence, before investing one should carefully analyze the portfolio of the scheme.

In case of equity funds, one should analyze the stocks owned by the fund. For example, if the fund has a high proportion of large-cap stocks in the portfolio, one can expect steady returns and less volatility compared to mid-cap or small-cap stocks. This will also help the investor to determine projected returns from the fund.

While investing in hybrid funds one should ensure that it complements the financial goals. Dynamic hybrid funds are ideal for investors who want flexible auto-balancing and do not want to worry about asset allocation.

Most importantly, the investor must consider his risk tolerance, financial goal and investment tenure before picking a hybrid fund. For those who require regular income, they can invest in debt-oriented hybrid funds which can help them to generate better returns than a pure debt fund due to the equity component.

Mutual fund investments carry certain market risk. Therefore, before investing every investor must consult his financial adviser to ensure the right selection of the fund.

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