What are Hybrid Funds? What are the different types of Hybrid Mutual Funds?

Published On: 19-Dec-2021

It is always advised, "one should not have all its eggs in the same basket." This advice works well in the investment world, as no single asset class has always been a winner for investors. As such, the investors tend to prefer having a diversified investment portfolio across different asset classes.

However, to have a diversified portfolio, an investor may hold multiple schemes investing in different asset classes. This is where hybrid funds come to the rescue of the investors, enabling them to have multiple asset classes within a single mutual fund scheme.

Hybrid Funds enjoy the flexibility to invest in both equity markets and debt securities simultaneously. The investors may benefit from the long-term potential of higher returns through the equity component and enable portfolio stability through the debt component.

Further, the hybrid funds may also invest in other asset classes, like real estate, gold, etc., depending upon their investment mandate. Even within the broad category of hybrid funds, investors can choose between seven sub-categories depending on the targeted asset allocation. This enables them to select the mutual fund scheme best suiting their risk appetite and investment horizon.

Hybrid funds can be classified into the following categories:

  1. Conservative Hybrid Fund – Such funds are open-ended mutual funds investing predominantly in debt securities (75% to 90% of the net assets) and the remaining allocation to the equity securities (i.e. 10% to 25%). 
  2. Balanced Hybrid Fund – As the name suggests, such funds will maintain a balanced approach and have the flexibility to invest 40% to 60% of the net assets in equity instruments and similarly, 40% to 60% in debt instruments. For example, if the fund plans to invest 55% in debt securities, it can decide to allocate 45% to equities. Further, no arbitrage is permitted under balanced hybrid schemes.
  3. Aggressive Hybrid Fund – Such funds are open-ended mutual funds investing predominantly in equity and equity-related instruments (65% to 80% of the net assets) and the remaining allocation to the debt securities (i.e. between 20% to 35%).
  4. Dynamic Asset Allocation Fund – Such funds, also known as 'balanced advantage funds', carry the flexibility within their investment mandate to invest across equity and debt. The allocation is managed dynamically depending upon the relative valuations of equity and debt. Such funds will increase the equity allocation when the equities are trading at lower valuations. In contrast, the fund will lower the equity valuation and book profits when the valuations seem expensive. As such, these funds adopt the 'buy low and sell high' strategy. 
  5. Multi-Asset Allocation Fund – Such funds invest in at least three asset classes with a minimum 10% allocation to each of the three asset classes. 
  6. Arbitrage Fund – Such schemes adopt arbitrage strategies to generate returns for the investors with a minimum 65% investment in equity and equity-related securities. However, the fund's equity exposure is suitable hedged through derivative strategies, thereby mitigating the equity investment risk for the investors. Arbitrage refers to the difference in the equity valuations in the cash and futures markets. Since cash and futures markets converge on the expiry date, the fund managers capitalize on the valuation differential to generate returns with minimal investment risk over time. 
  7. Equity Savings Fund – Such funds are open-ended funds investing in equity, debt, and arbitrage opportunities. However, by investment mandate, such funds must invest at least 65% of their net assets in equity and equity-related securities and a minimum of 10% in debt securities. The equity exposure is generally hedged through derivative contracts, and the fund must disclose the minimum hedged and unhedged exposure in the Scheme Information Document (SID).

With different types of hybrid funds available for the investors, all investors may get the right fund suiting their financial goals, investment horizon, and risk-bearing ability. For example, a conservative hybrid fund may be more suitable for investors with short-term goals.

In contrast, investors may consider investing even in aggressive hybrid funds for their long-term financial goals. Similarly, investors can also consider investing in dynamic asset allocation funds, wherein the allocation is managed dynamically as per their relative valuations.

With asset allocation being crucial to the success of any investment strategy, the investors may consider hybrid funds to manage their asset allocation conveniently and effortlessly.