Hybrid Mutual Funds

Whenever we think about investing in mutual funds, one of the first thoughts that strikes our mind is whether to invest in debt funds or equity funds-the two broad categories which most people are aware about. Some may prefer holding an all equity portfolio, while some may stick to the relatively less riskier debt funds to invest their hard earned money. However, amidst the constant worry of balancing your portfolio as per the respective pros and cons of equity and debt funds, instead investing in another category of mutual funds can be your saviour. By investing in this category, you can enjoy the benefits of both equity and debt funds in a balanced way, as per your risk appetite and investment horizon. Curious about what this is?

This category is none other than hybrid mutual funds. By investing in both equity and debt funds, these funds can prove to be the solution to your constant worry of having the right mix of debt and equity funds in your portfolio in order to achieve your financial goals timely.

Let¡¯s first understand what hybrid funds are, and then deep dive into the entire gamut surrounding them:

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Understanding Hybrid Mutual Funds

As their name suggests, Hybrid mutual funds invest in two or more asset classes, which is usually a combination of equity and debt in most cases, aimed to offer a balanced component to your portfolio and achieve the set investment objective of that scheme. And, in order to cater to varying risk appetites, investment horizons and financial goals of different investors, each hybrid fund scheme involves a different proportion of equity and debt investment allocation. These funds possess the ability to provide the investor with the best of both worlds, equity and debt, and specially work well for investors who are apprehensive or not keen towards stepping into an entirely equity or debt portfolio, but wish to avail the benefits of the other not chosen category. In totality, hybrid funds are termed as a suitable investment for a medium-term investment horizon and are ideal for investors who are aiming to grasp a mix of safety, income and modest capital appreciation. In terms of risk, they can be considered riskier than riskier than debt funds but safer than equity mutual funds.

Categories of Hybrid mutual fund schemes

As per SEBI¡¯s current re-categorization of Mutual Fund Schemes, October 2017, Hybrid funds are categorized into seven categories:

Aggressive Hybrid Funds- Equity proportion of 65% - 80% of total assets ; Debt proportion: 20% - 35% of total assets

Conservative Hybrid Funds - Equity proportion of 10% - 25% of total assets ; Debt proportion: 75% - 90% of total assets

Balanced Hybrid Funds - Equity proportion of40% - 60% of total assets ; Debt proportion: 40% - 60% of total assets

Dynamic Asset Allocation or Balanced Advantage Funds - Proportion of Debt and Equity is dynamically managed by the fund manager, depending upon market valuations.

Multi Asset Allocation- Invests in at least 3 asset classes, with a minimum allocation of at least 10% each in all each of the chosen asset classes.

Arbitrage Fund- Follows the strategy of investing in arbitrage opportunities. Minimum investment in equity and equity related instruments has to be 65%.

Equity Savings- Invests in equity, arbitrage and debt. Minimum investment in equity and equity related instruments has to be 65% ; Minimum investment in debt has to be 10%. Minimum hedged & un-hedged allocation to be stated in the SID (Scheme Information Document).

(Note that, as per SEBI guidelines and circular dated October 2017, mutual funds are permitted to offer either a Balanced fund or an Aggressive hybrid fund.)

Why go for hybrid funds for diversification?

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Whether you are a newbie aiming to build a diversified mutual fund portfolio, or an existing investor already having either solely equity or debt investments in the portfolio and aiming to diversify, there are two ways to do it. One way to diversify is by adding the other not yet included category into your portfolio, which is debt in case you already have equity funds, and equity in case you already have invested in debt funds. While this option might seem like a low hanging fruit which can be picked quickly and easily, the reality is rather different.

To add equity or debt funds into your portfolio, you would require a lot of research and decision making regarding choosing amongst a wide variety of categories under debt and equity fund schemes, such as large cap, small cap, multi cap, mid cap, liquid, ultra short duration, overnight funds etc to name a few. And in case you end up choosing the inappropriate schemes that do not contribute towards fulfillment of your goals, then you would have rejig your portfolio again and re-invest in better and appropriate schemes, which meanwhile can cause capital erosion in case you are forced to redeem those underperforming or inappropriate schemes during the red phase of your portfolio.

Whereas on the other hand, when you opt for the second way of sliding a level of diversification into your portfolio through investment in hybrid funds, you would relatively have an easier way out, as there are just a handful of categories under hybrid funds, and it would not be your but the chosen hybrid scheme¡¯s fund manager¡¯s task to take care of most of the balancing of equity-debt portion, thus freeing you from the need to balance this component in your portfolio, besides also ensuring that the fund manager¡¯s expertise and knowledge are the driving factors behind the fund¡¯s selection of investments, thus boosting the chances of performing well.

Performance of Hybrid Funds- Returns vs Equity and Debt Funds

Let us have a look at category average returns of some of the categories of Hybrid,Equity and Debt Funds to give you a fair idea about how these categories¡¯ returns weigh against each other.

Hybrid Mutual Funds

Aggressive Hybrid

1 Year returns-46.95%

3 Year returns-19.54%

5 Year returns-13.71%

Conservative Hybrid

1 Year returns-16.46%

3 Year returns-10.34%

5 Year returns-8.17%

Balanced Hybrid

1 Year returns-31.16%

3 Year returns-13.73%

5 Year returns-9.19%

Multi asset allocation

1 Year returns-33.91%

3 Year returns-16.60%

5 Year returns-10.78%

Debt Mutual Funds

Long duration

1 Year returns-3.37%

3 Year returns-10.80%

5 Year returns-7.88%

Short duration

1 Year returns-5.37%

3 Year returns-7.30%

5 Year returns-6.92%

Liquid Funds

1 Year returns-3.26%

3 Year returns-4.95%

5 Year returns-5.69%

Equity Mutual Funds

Large Cap

1 Year returns-54.38%

3 Year returns-21.65%

5 Year returns-15.68%

Mid Cap

1 Year returns-72.45%

3 Year returns-27.09%

5 Year returns-16.79%

Small Cap

1 Year returns-89.35%

3 Year returns-29.24%

5 Year returns-17.84%

(All Data Source: Valueresearch, returns of direct plans, as on 28.10.2021)

Final Words

On one hand, debt funds are termed as a suitable mutual fund category for risk averse investors who are content with low to moderate returns. Debt funds involve a lower degree of risk and volatility, as they invest in fixed income securities such as corporate bonds, treasury bills, commercial papers, government securities, and various other money market instruments.

Whereas on the other hand, equity funds are deemed suitable only for the risk takers, as these funds predominantly invest into the shares of different companies across different themes,sectors, market cap etc. While the returns of equities hold an immense upside potential and have historically outperformed almost all other asset classes as well as inflation by a wide margin, especially over the long term, there is no denying the fact that they can be highly volatile in nature, especially in the short term.

Hence, instead of solely relying on market trends and past performances of a single asset class, whether equity or debt, you can invest in hybrid mutual funds. By offering the twin benefits of high potential returns during the equity market boom and capital protection through debt component to tackle the downfalls, Hybrid funds serve as an excellent investment avenue for investors willing to get the taste of equities as well as their potentially high returns without getting entirely exposed to the volatility of equity market. While the risk in hybrid funds would depend upon the proportion of equity holding in its overall portfolio, this degree of risk is likely to be lower than that of an all equity investment. And the presence of debt component in hybrid funds is what offers the investor capital protection and stability, apart from acting as a cushion during market downsides.