Types of Hybrid Funds

Hybrid funds are a type of investment vehicle that combines the features of both equity and debt instruments. They spread out risk by putting money into different types of assets. They try to find a balance between risk and return. These funds give investors a mix of growth potential and income, so they can choose how much risk they want to take. The types of hybrid funds are:

• Conservative Hybrid Fund
• Balanced Hybrid Fund
• Aggressive Hybrid Fund
• Dynamic Asset Allocation Fund
• Multi Asset Allocation Fund
• Arbitrage Fund
• Equity Savings Fund

Content:

• What Is Hybrid Mutual Fund?
• Types Of Hybrid Mutual Funds
• Types Of Hybrid Funds – Quick Summary
• Frequently Asked Questions

What is Hybrid Mutual Fund?

Hybrid mutual funds distribute invested funds between equity and debt instruments in varied proportions. There are, in total, seven types of hybrid mutual funds that are categorized by SEBI. The rules for the minimum and maximum proportion to be invested in equity and debt instruments for each type of hybrid fund are provided by SEBI.

The equity-oriented hybrid funds, which invest at least 65% of their assets into equity and related instruments, are taxed according to the taxation rules of equity mutual funds. So, if the fund is held for one year, the earnings are termed short-term capital gains (STCG), which are taxed at a rate of 15%. If the fund is held for more than a year, the earnings are termed long-term capital gains (LTCG), which are taxed at 10% for gains of more than ₹1 lakh. 

If the fund is held for more than 36 months, it is termed as LTCG, which is taxed at a rate of 20% with indexation benefits. The debt-oriented hybrid funds with an exposure of a maximum of 35% in equity instruments will be taxed as per the investor’s tax slabs, whether an STCG or LTCG. 

Types of Hybrid Mutual Funds

The full list of types of hybrid mutual funds are: 

• Conservative Hybrid Fund
• Balanced Hybrid Fund
• Aggressive Hybrid Fund
• Dynamic Asset Allocation Fund
• Multi-Asset Allocation Fund
• Arbitrage Fund
• Equity Savings Fund
• Monthly Income Plan

Conservative Hybrid Fund

Conservative hybrid funds are the funds that invest at least 10% of their corpus into equity and related instruments, which can go up to a maximum of 25%. In terms of debt and related instruments, they invest a minimum of 75% and a maximum of 90%. They are ideal for risk-averse investors who don’t want to take high risk. 

Conservative hybrid funds are taxed based on the investor’s respective income tax slab, regardless of short-term or long-term capital gains. This rule is valid for investments made on or after April 1st, 2023.

Balanced Hybrid Fund

Balanced hybrid funds must invest at least 40% of their corpus into equity and related instruments, which can go up to a maximum of 60%. It invests the same proportion into debt and related instruments, which are 40% to 60%. Therefore, they carry a higher risk than the conservative hybrid funds but can also provide a higher return with the extra exposure to equities. 

The taxation of balanced hybrid funds will depend on whether it is an equity or debt-oriented fund. Therefore, depending on the equity or debt proportion, the tax rates will be applicable, and the benefits will be provided similarly. 

Aggressive Hybrid Fund

Aggressive hybrid funds invest at least 65% of their corpus into equity and related instruments, which can reach 80%. It invests at least 20% of its corpus into debt and related instruments, which can go up to a maximum of 35%. 

Since they invest more than 65% of their assets into equity instruments, the earnings from these types of hybrid funds are taxed similarly to the equity mutual funds, and therefore the earnings of up to ₹1 lakh in a year are completely tax-free. 

Dynamic Asset Allocation Fund

Dynamic asset allocation funds have the flexibility to invest anywhere between 0% to 100% in both equity and debt instruments. Managed by the fund manager, these funds can dynamically shift across assets such as equity, debt, derivatives, real estate, and more.

Multi-Asset Allocation Fund

Multi-asset allocation funds are mandated to allocate at least 10% of their corpus in three distinct asset classes: equity, debt, financial derivatives, gold, or real estate. Ideal for a minimum investment horizon of five years, these funds pose the lowest risk compared to other hybrid types, thanks to their diversified investments beyond mere equity and debt instruments.

The fund’s distribution across various asset types fluctuates in response to market conditions, yet a 10% allocation for each asset is required. The fund’s taxation hinges on the dominant asset class, essentially whichever asset is held in higher proportion.

Arbitrage Fund

Arbitrage funds are a type of hybrid mutual funds that aim to generate returns through the arbitrage strategy. These funds typically invest a significant portion of their corpus (at least 65%) in equity and equity-related instruments.

In the context of arbitrage, these funds exploit price differentials between the cash and futures markets. They do this by simultaneously buying a financial instrument (such as stocks or derivatives) in the cash market and selling it in the futures market, taking advantage of any pricing discrepancies. The goal is to profit from the convergence of prices over time.

Equity Savings Fund

An equity savings fund must invest at least 65% of its assets into equity and related instruments. This fund invests at least 10% of its assets into debt instruments and some percentage in derivatives, as mentioned in its SID (Scheme Information Document). Hence, this fund provides the triple benefits of equity diversification, arbitrage opportunities, and the safety of debt instruments. 

They are best for investors who are risk averse and have an investment horizon of short to medium term. They are safer than equity funds and are more tax efficient than debt funds if they are held for more than a year because they are taxed similarly to any other equity-oriented funds. 

Monthly Income Plan

Monthly Income Plans (MIPs) are a type of hybrid mutual fund not categorized by SEBI but definitely need to be known. They are similar to debt-oriented hybrid mutual funds, and they provide a regular income to investors through dividends. The frequency of dividend payment can be a monthly, quarterly, yearly, or re-investment option decided by the investor. 

They invest mainly in debt instruments within a range of 75% to 85% and the remaining 15% to 25% in equity instruments. The taxation rules applicable to these funds are the same as those applied to debt-oriented mutual funds. The dividend income is taxed based on the investor’s income tax slabs, for which the total dividend income is added to the total income. A dividend income of more than ₹5,000 in a financial year will attract a TDS of 10%. 

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Types of Hybrid Funds – Quick Summary

• The types of hybrid funds are conservative hybrid funds, balanced hybrid funds, aggressive hybrid funds, dynamic asset allocation funds, multi-asset allocation funds, arbitrage funds, etc. 
• Hybrid mutual funds are the type of mutual funds that invest their collected corpus into a mix of equity and debt instruments. 
• From the different types of hybrid funds, a conservative hybrid fund is less risky when compared to a balanced hybrid fund or an aggressive hybrid fund.
• There are arbitrage hybrid funds that follow the arbitrage strategy to make the maximum profits from price differentials in two markets. 

Frequently Asked Questions