We’ve all unintentionally learned the phrase, “Mutual funds are subject to market risk. You should read all scheme-related documentation carefully before investing,” don’t we? As a result, “where there is an investment, there is a risk” applies. And each investor has a varied capability for taking risks. While some investors incur high risk to receive a high return, others are content to accept a low risk and poor return. However, some investors choose to adopt a balanced strategy that involves taking modest risks and aiming for moderate returns. The best choice for these investors is hybrid funds.
What are hybrid funds?
More than 65% of the fund corpus is invested in equities/stocks or debt instruments, depending on the equity or debt fund. In the case of hybrid funds, asset allocation is done to maintain a balanced ratio between equity and debt instruments. It may allocate between 40 and 60 per cent of the funds to one asset class and the remaining to another. Hybrid funds might be more equity- or debt-oriented depending on how much of their assets are invested in stocks and bonds. Depending on the market’s state, certain funds can dynamically alter their asset allocation ratio.
Types of Hybrid Funds
- Multi-Asset Allocation Funds: These plans must invest in at least three different asset classes, with a minimum of 10% in each of them. These funds expose investors to investing in more asset classes, and the asset allocation is determined based on the fund manager’s opinion.
- Balanced Hybrid Funds: These plans allocate between 40 and 60 per cent of their assets to both equity and debt asset classes. The goal is to achieve long-term wealth generation through investments in the equities asset class and risk management through debt allocation. The use of arbitrage is prohibited in this class of schemes.
- Aggressive Hybrid Funds: These plans are required to invest between 20 and 35 per cent of their assets in debt and between 65 and 80 per cent of their assets in the equity asset class. By just allocating a tiny portion of their assets to debt, they offer the chance of large returns at low risk. They gain from the tax laws that apply to equity-oriented plans.
- Equities Savings Funds: These funds invest in equity, derivatives, and debt in an effort to balance risk and rewards. By lowering the exposure to directional equities, derivatives lower volatility and produce a consistent return. Growth and debt are provided by equities assets, while derivatives provide regular, steady returns. These schemes make investments that range from 0 to 35% in debt asset classes and 65 to 100% in equity assets.
Benefits of Hybrid Funds
- Access numerous asset classes with a single fund: One of the obvious benefits of hybrid mutual funds is that an investor may access many asset classes in a single product rather than investing in separate products to meet the need for various asset classes.
- Active Risk Management: Through asset allocation and portfolio diversification, hybrid mutual funds offer active risk management. By merging uncorrelated asset classes like debt and equity, they reduce risk.
- Diversification: In addition to diversifying the portfolio across asset classes, they also do so within each class of assets. They invest in large-, mid-, or small-cap equities, as well as in value- or growth-oriented firms, just like the overall equity allocation.
- Buying low and selling high: The fund managers rebalance the portfolio to modify the asset allocation within the permitted limit, which results in selling a particular asset class when it is high and buying it when it is low.
- Automatic Rebalancing: The portfolio is automatically rebalanced by the fund manager when needed; the investor is not required to do so. They reduce the time and effort needed to manage asset allocation and track the markets.