Hybrid Funds are a type of Mutual Fund that invest in both equity and debt to provide investors capital appreciation and regular income. The Securities Exchange Board of India (SEBI) has made seven categories for Hybrid Funds. Hybrid Funds have been categorized based on their asset allocation. These categories are:
- Conservative Hybrid Fund
A Conservative Hybrid Fund invests predominantly in debt instruments. Investments in debt instruments are between 75% to 90% and investments in equity are between 10% to 25%. These funds seek to provide their investors with a regular income through investments in debt instruments and capital appreciation through investments in equity. Conservative Hybrid Funds are suited to investors with a low to moderate tolerance for risk and long investment horizons of at least 3 years.
As Conservative Hybrid Funds never take more than 65% exposure to equity, they are considered debt funds for the purpose of taxation. Therefore, if investments in these funds are held for less than 3 years returns will be taxed according to the investor’s tax slab. If the investment duration is more than 3 years returns will be taxed at 20% after indexation.
- Balanced Hybrid Fund*
Prior to SEBI’s categorization of Mutual Funds, Balanced Hybrid Funds were vaguely defined and invested between 65% to 80% in equity and between 20% to 35% in debt, this was a little confusing to investors as the name “balanced” would suggest that they invest equally in debt and equity. Therefore according to the new SEBI categorization of Mutual Funds balanced funds need to invest between 40% to 60% in debt and between 40% to 60% in debt and funds that invest 65% to 80% in equity and between 20% to 35% in debt are now called Aggressive Hybrid Funds. A fund house is allowed to offer only one Balanced Hybrid Fund to investors and it cannot offer both a Balanced Hybrid Fund and an Aggressive Hybrid Fund. Balanced Hybrid Funds are suitable for investors with a moderate tolerance for risk and investment horizons of at least 3 years.
As balanced funds never have more than 65% of their assets in equity, they are considered debt funds for the purpose of taxation. Therefore, if investments in these funds are held for less than 3 years returns will be taxed according to the investor’s tax slab. If the investment duration is more than 3 years returns will be taxed at 20% after indexation.
- Aggressive Hybrid Funds*
Aggressive Hybrid Funds invest between 65% to 80% of their assets in equity and 20% to 35% in debt instruments. These funds are a little riskier than Balanced Hybrid Funds due to their slightly more aggressive investment style as a result of their higher exposure to equity. Aggressive Hybrid Funds provide investors with regular income through their debt investments and capital appreciation through their equity investments. The debt portion of the portfolio can provide safety to the fund in case equity fails to perform.
As Aggressive Hybrid Funds take an equity exposure of at least 65%, they are considered equity funds for the purpose of taxation. Therefore, returns on investments held for less than a year are taxed at 15%. If an investment is held for more than a year, Long-Term Capital Gains (LTCG) Tax is applicable for returns above Rs. 1 lakh at 10%. LTCG Tax on returns above Rs. 1 lakh is only calculated for the year of redemption and not for every year of investment.
Aggressive Hybrid Funds are suitable for investors with a moderately high tolerance for risk and investment cycles of at least 3 years.
*Please note: A fund house can offer either a Balanced Hybrid Fund of an Aggressive Hybrid Fund, not both.
- Dynamic Asset Allocation / Balanced Advantage Funds
Dynamic Asset Allocation Funds are actively managed open-ended mutual funds. These funds can dynamically allocate assets towards equity of debt instruments based on the prevailing market conditions. These funds follow a basic ‘buy low, sell high’ strategy i.e. when equity markets are going through a bullish phase the fund manager invests in debt instruments to protect the fund against future market corrections in case the equity market is overvalued. The fund invests in equity instruments during bearish phases to take advantage of stock appreciation after the market settles. As assets are dynamically allocated between debt and equity based on market conditions and there is no fixed asset base, there is no particular frequency of asset rebalancing.
- Multi-Asset Allocation Funds
A Multi Asset Allocation Fund invests in at least 3 asset classes with a minimum of 10% invested in each asset class. Multi-Asset Allocation Funds are open-ended, actively managed equity funds that dynamically allocate their assets towards various asset classes according to market conditions. These funds can provide investors with good diversification and, thereby, dilute the overall risk of the portfolio as each asset class carries its own risk-return profile.
- Arbitrage Funds
Arbitrage is the buying and selling of assets in different markets to benefit from the price difference of these assets in different markets. Arbitrage Funds do not invest in the fundamentals of stock and, therefore, are free of the risks associated with equity investments. Arbitrage Funds are open-ended, actively managed hybrid mutual funds that invest a minimum of 65% towards equity and equity-related instruments. These funds perform best during volatile market cycles.
As Arbitrage Funds take a minimum exposure of 65% towards equity and equity related instruments they are considered equity funds for the purpose of taxation. Therefore, returns on investments held for less than a year are taxed at 15%. For investments held for 1 year or more LTCG is taxed at 10% for returns over Rs. 1 lakh. LTCG Tax is only calculated on the returns for the year of redemption and not for the returns during the entire investment cycle. These funds provide similar returns to Liquid Funds. Arbitrage Funds are suited to investors that have short investment cycles of 1 year and have a low tolerance for risk.
- Equity Savings Fund
Equity Savings Funds are open-ended funds that invest in equity, arbitrage, and debt instruments. These funds seek to generate returns from investment in equities, arbitrage trades and fixed income securities. Equity Savings Funds mitigate volatility by actively hedging their portfolios through derivatives. Equity and Arbitrage trades are considered equity according to SEBI and these funds take a minimum of 65% exposure to these instruments, therefore, these funds are considered equity funds for the sake of taxation.
Equity Savings Funds are suited to investors that have long investment horizons of at least 3 years and a moderately high tolerance for risk.