How hybrid funds work and how safe are they?

What are Hybrid Funds?

Hybrid funds are the combination of debt and equity instruments which are designed to avoid concentration of assets and increase diversification. These funds are customized to cater to the investors’ need, therefore having different combination of equity and debt for different types of investors.

How do they work?

Hybrid funds are having 2 major goals:

1. Capital Appreciation in the long term – By investing in equity you can get capital appreciation
2. More/higher returns in short term- By investing in debt instruments, you can get stable returns.

Hybrid fund managers keep the above-mentioned goals in mind while allocating the assets. They analyze the market to make sure that returns and capital appreciation are in place. The fund manager then creates a portfolio as per the investment objective of the scheme and allocates the funds in equity and debt instruments in varying proportions.

What are different types of Hybrid funds?

Based on the asset allocation, Hybrid funds are further classified into different categories. Let’s try to understand them in detail!

Equity-oriented hybrid funds: When the fund manager invests more than 65% of funds in the form of equity and the rest in debt and money market instruments, then that allocation of assets is known as an equity-oriented fund. It would best suit the investors who are willing to take risk. The equity feature of the fund comprises of equity shares of companies across industries such as FMCG, finance, healthcare, real estate, automobile, and so on.

Debt-oriented hybrid funds: A hybrid fund can be called as a debt-oriented fund when the fund manager invests major part into debt instruments and rest in equity and other money markets instruments. The debt feature of the fund comprises of investment in fixed-income instruments such as government securities, debentures, bonds, treasury bills, and so on. Debt-oriented hybrid/balanced funds could be used as monthly income for investors who want an alternate source of income. For the sake of liquidity, some part of the Debt-oriented hybrid fund would also be invested in cash and cash equivalents.

Monthly Income Plans: Monthly Income plans are designed to provide regular income to the investor in the form of dividends. These are hybrid funds that invest mostly in debt and some amount in equities. Investors can choose the time period of dividend payout; it can be monthly, quarterly, half-yearly, or annually. MIPs are hybrid funds as these invest majorly in debt instruments. A monthly income plan (MIP) would normally have 15-20% exposure to equities. It would benefit the investors by generating higher returns than regular debt funds.

MIPs are also equipped with the growth option as they can leave the investments to grow in the fund’s corpus. Hence, a MIP is not an ordinary monthly income investment. Do not get mislead by the name.

Arbitrage Funds: An arbitrage fund manager tries to maximize returns by taking the advantage of price changes in the markets. Arbitrage funds are relatively safe, like debt funds. Fund managers earn profits by simultaneously buying the stocks in cash markets and selling them in derivatives markets. With their deep insights and financial wisdom, fund managers identify the arbitrage opportunities. Although when they cannot see any arbitrage opportunity, these funds would invest into debt instruments or cash. These are best suited to investors who are having short term horizon.

Advantages of investing in hybrid mutual funds

Equity mutual funds are suited for investors who are ready to bear the high risk in order to reap higher benefits while Debt mutual funds are suited for investors who do not want to take high risk and are willing to accept lower returns in the form of regular but lower return with lower risk. So, what to choose?

Hybrid funds are suitable for investors who look for a balanced risk and rewards. Following are the major advantages of hybrid mutual funds:

Balancing risk and return: Best advantage of investing in a hybrid mutual fund is that it lets the investors to balance the risk and return. The equity part will give better returns, and the debt portion will give steady returns at lower risk. Investors can always pick up that blend of equity and debt that is catering to their needs.

Diversification: A Hybrid fund provide the benefit of diversification since it is a combination of both equity and debt. When share prices fall, the debt component in hybrid mutual funds ensures stability thereby absorbing shocks during a sluggish phase. By diversifying, hybrid fund can help you hedge against adverse shocks in the markets.

Systematic investment plan (SIP): Hybrid funds allow you to invest small amounts each month through SIP depending on your monthly savings. Is there any advantage in investing small amount over a period? Some investors are of the opinion that it doesn’t matter whether you invest a lump sum or in instalments when you are investing mainly in debt. But it will obviously matter if the hybrid funds have a higher portion of equity because then you may be in danger of getting into the stock market when prices are high. In hybrid funds with a higher part of equity, it is better to invest through the SIP route in order to enjoy the benefit of rupee cost averaging.

Less volatility: Equity funds are subject to the risks of the market. In a volatile market, investors could get nervous and exit through redemptions. Having a debt feature brings stability to hybrid mutual funds and fund managers will be able to handle redemptions better and ensure stable returns to investors.

Comparative analysis table of hybrid funds and equity funds

Conclusion: Hybrid mutual funds are suited for different variety of investors having different investment and risk profiles. There are equity-oriented schemes for the risk-takers and debt-oriented schemes for the risk-averse investors. Hybrid funds offer varying levels of risk tolerance ranging from conservative to moderate to aggressive. People who have retired can also choose hybrid funds to manage their expenses by adopting a conservative strategy. These could also be a good base for new entrants given their balanced structure. So, we can safely say that hybrid mutual funds cater to everyone’s financial goals.

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