Mutual Funds have seen growing demand from investors over the years. However, they’re still perceived as a high-risk investment instrument.
That notion is not entirely true, as Mutual Funds are not always high-risk. There are broadly three types of Mutual Funds: Equity Mutual Funds, debt Mutual Funds, and hybrid funds that invest in both equity and debt.
The risk and the reward matrix varies with each variety of Mutual Fund. Equity funds are high risk and debt funds are typically low risk, but hybrid funds straddle the divide.
In this article, we will take a look at hybrid funds. If you’re a risk-averse investor looking for above-average returns, this might just be your cup of tea.
Hybrid funds – a mix of debt and equity
A hybrid fund invests in both equities and debt. Debt Mutual Funds invest in instruments that fetch fixed returns: think sovereign bonds and corporates deposits. Equity investing, on the other hand, makes no promise of returns.
A hybrid Mutual Fund can give you the best of both worlds. They fare well due to their underlying equity assets when the markets are rising, and they can cushion the blow of a falling market due to their underlying debt instruments. The proportion in which the fund is allocated between equities and debt is determined by the objective of the fund.
Types of hybrid funds
Based on the mix of equity and debt, hybrid funds can be categorised into two types; equity-oriented hybrid funds and debt-oriented hybrid funds. Mutual Funds with 65% or more of the fund invested in debt are known as debt-oriented Mutual Funds, while those with 65% or more invested in equities are called equity-oriented Mutual Funds.
Things to consider while selecting hybrid funds
Start with assessing your risk profile. While hybrid funds are best for investors with moderate risk appetite, there are varieties within them. For example, some funds will invest up to 10% in equity and the rest in debt. Other funds can go up to 20% or 30% in equity.
You should also have an understanding of the long-term returns of the fund by looking at the 5-10 years CAGR. It gives you a benchmark to set expectations accordingly.
As far as tax is concerned, the equity-oriented hybrid funds do not have any long-term capital gain tax associated with them. However, the short-term capital gain tax is deducted at 15%. In case of debt-oriented funds, the short-term capital gain tax is deducted as per your income slab and the long-term capital gain tax is deducted at 20% with indexation.
In case of equity-oriented hybrid funds, a period longer than 12 months is considered to be long term, while for debt funds, 36 months is considered long term.
Additional Reading: Taxation of SIP investments
If you are a risk-averse investor, hybrid Mutual Funds could be the right investment instrument for you as it strikes the perfect balance between risk and returns.