Normally the term hybrid fund is used quite loosely. As the name suggests, hybrid means a combination. In the context of mutual funds, it is a combination of ‘Equity and Debt’. According to the latest SEBI categorization of mutual funds, under the category of hybrids, there are 4 broad sub-sets:
- Equity Balanced Funds (more than 65% in equity)
- Monthly Income Plans (predominantly debt and a small portion in equity)
- Arbitrage fund (combination of equity and stock futures)
- Allocation Plan (where the equity/debt can be modified as per view)
How do these 4 fund categories fit into an investor’s portfolio?
- How do equity balanced funds fit into your portfolio
Instead of the investor making the decision of how much to allocate between equity and debt, the balanced fund takes that decision. It also gives you the added benefit of professional fund management and professional asset selection. This return on a balanced fund is much higher than what pure debt funds give and only slightly lower than what pure equity funds have given. In fact, in falling interest rate scenarios, these balanced funds have even performed better.
The real icing on the cake is when it comes to balanced funds are tax benefits; similar to that of equity funds. Currently, balanced funds with a minimum exposure of 65% to equities are classified as equity funds for tax purposes. It makes a big difference in the way capital gain is treated. Capital gains on a debt fund are classified as short-term if it is held for less than 3 years and taxed at your peak rate. If you hold the debt funds beyond the period of 3 years then it becomes long-term capital gains and is taxed at 20% with indexation. On the other hand, capital gains on equity funds are treated as long-term if they are held for more than 1 year. In case of equity funds, short-term gains are taxed at 15% while long-term gains are now taxed at a concessional rate of 10% above Rs.1 lakh. However, there is no indexation benefit available here. That is why balanced mutual funds become critical. They not only get the benefit of equity exposure but also are more tax-smart.
Some of the top performing funds in this category in terms of 1 year returns are Mirae Asset GCF, Axis EAF, Tata RSF, UTI CCF etc.
- Powering MIPs with a higher debt component
Monthly Income Plans (MIP) has emerged as a distinct asset class category within mutual funds. To put things in perspective, MIPs are the reverse of equity balanced funds. A MIP maintains 75-80% exposure to debt and only the balance is invested in equity. The idea is to combine the capital appreciation of equity with the stability and regular returns of debt.
For taxation purposes, a MIP remains a debt fund but due to its higher debt exposure, the MIP is safer and also ensures regular income with a greater degree of certainty. Thus MIPs are extremely suitable for senior citizens who want to get that extra bit advantage from their mutual fund investments without compromising on safety. At the same time, the small exposure to equities ensures above-market returns and enhances the returns on the MIP overall compared to pure debt funds.
A MIP is not only a debt-oriented fund with a small exposure to equities but also pays out dividends on a regular basis. That is how the name MIP comes in but it needs to be remembered that there is no assurance of returns in this case. The name, by itself, may make it look like an assured return scheme, which it is not. Monthly Income Plans (MIP) is a very good entry level product for retail investors who can start off with conservative fund products with a small exposure to equities and then go higher on the equity plan once they are more comfortable with the risk of equities. They can get comfortable with MIP and then look at equity exposure in a bigger way.
Some of the better performing debt oriented MIPs over the last 1 year include Axis Triple advantage, SBI Magnum, Quantum Multi-Asset, Tata RSF (Conservative), UTI CCF (Savings Plan) etc.
- Replicating debt profile with an equity product
Arbitrage funds combine equity and stock futures in the same proportion and lock in the stock-future spread (Long Stock/Short Futures). This becomes like an assured return for the fund as cash and futures expire at the same price on the F&O expiry day. Since the spread is based on interest rates, this becomes like debt fund that is rolled over each month. But, what about taxation of these arbitrage funds? That is where the advantage kicks in. These arbitrage funds are more than 65% invested in equities as futures are leveraged products. This gives them an advantage of being treated as equity funds for tax purposes.
Some of the better performing arbitrage funds on a 1 year basis are Reliance Arbitrage Fund, Axis Arbitrage Fund, SBI Arbitrage Fund, Edelweiss Arbitrage Fund, Kotak Arbitrage etc. In the last one year, most arbitrage funds have given around 7% returns.
- Dynamic or allocation funds
This is a unique kind of hybrid fund where the fund manager has the discretion to increase the exposure to debt and to equity based on the view on interest rates and valuations. However, these funds run the risk of fund manager bias and investors must opt for these funds cautiously.
Hybrid funds cover a much wider audience rather than covering purely aggressive or purely conservative audiences. That is where hybrids add value to investors.
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