Types of Mutual Funds — Hybrid Funds

This is the last blog in our series of ‘Understanding the types of mutual funds ’. After understanding equity mutual funds and debt funds, this blog will focus on hybrid funds. Hybrid funds invest in a combination of asset classes such as equity, debt and gold. The allocation to the different asset classes depends upon the investment objective of the fund. As the risk profile of each asset class is different, returns from the scheme will depend upon the allocation to each asset class and the type of securities in each asset class. In other words, the risk is higher if the equity component is higher. Similarly, the risk is higher if the debt component is invested in longer term debt securities or lower rated instruments.

Debt-oriented Hybrid Funds

Debt-oriented hybrid funds invest primarily in debt with a small allocation to equity. The equity allocation ranges from 5 to 30 per cent as prescribed in the offer documents. The debt component is conservatively managed to earn coupon income, while the equity component is expected to provide a boost to the overall returns.

1. Monthly income plan (MIP) — This is a type of debt-oriented hybrid fund that seeks to declare a dividend every month. However, there is no guarantee that a dividend will be paid each month. The term ‘monthly income’ is a bit of a misnomer and investors need to be cautious about it. With MIP generating returns higher than post office schemes or fixed deposits — MIP is best suited for traditional investors seeking marginally higher returns. Even the investors looking for alternative sources of income can look to invest in it. Retired professionals can generate periodic paybacks from these schemes to meet the contingency expenses. Even the newcomer to the investment world can use it as a stepping stone in the world of investment.
2. Multiple yield funds — These funds generate returns over the medium term with exposure to multiple asset classes, such as equity and debt. In this, the investment is divided as — 55 to 60 per cent in bonds, 25 to 30 per cent in government bonds and the balance of 10 to 15 per cent in equity-related securities. It is suitable for lower risk appetite strata.

Equity-oriented Hybrid Funds

Equity-oriented hybrid funds principally invest in equity, with a smaller portion invested in debt. One popular category among the equity-oriented hybrid funds is the balanced fund. These schemes provide investors simultaneous exposure to both equity and debt in one portfolio. While equity provides growth, the debt provides stability. The balanced funds can have fixed or flexible allocation between equity and debt depending upon the investment objective of the mutual fund scheme.

1. Capital protected schemes — This looks like a complex structured product but is a simple scheme. These are close ended schemes, which are structured to ensure that investors get their principal back, irrespective of what happens to the market. Fund managers invest in zero coupon government securities whose maturity is aligned to the scheme’s maturity. (Zero coupon securities are securities that do not pay a regular interest, but accumulate the interest, and pay it along with the principal when the security matures).
2. If one invests Rs. 10,000 in such a scheme for 5 years, Rs. 7130 would be invested in government securities yields 7 per cent at that time. After 5 years the same would be Rs 10,000. The rest Rs. 2,870 will be invested in riskier equity instruments. So, investors are assured of principal and equity and can generate additional alpha returns.
3. The asset allocation funds do not specify a minimum or maximum limit for each of the asset classes. The fund manager allocates resources based on the expected performance of each asset class. Again returns depend on the fund manager’s expertise.
4. Arbitrage funds — Arbitrage funds take opposite positions in different securities, so that the risk gets neutralised, but returns are generated. A simple arbitrage is buying at a lower rate in one exchange and selling higher at another exchange. However, the real arbitrage occurs in the future and options segment. Although these schemes invest in equity markets, the expected returns are in line with liquid funds.

Open Ended Hybrid Mutual Fund Schemes

1. Conservative hybrid fund: An open ended hybrid scheme investing predominantly (75–90 per cent) in debt instruments. While 10–25 per cent is made in equity and equity instruments.
2. Balanced hybrid fund is an open ended balanced scheme investing in equity and debt instruments. According to the scenario in markets 40–60 per cent is invested in debt or 60–40 in equity instruments to maximise the returns.
3. Aggressive hybrid funds invest predominantly in equity and equity-related instruments. Investment in equity and equity-related instruments shall be between 65–80 per cent of total assets while investment in debt instruments shall be between 20–35 per cent of total assets.
4. Dynamic asset allocation or balanced advantage It is an open ended dynamic asset allocation fund with investment in equity/debt that is managed dynamically. It is perhaps the best and most suited investment vessel in an uncertain market as investments are widely spread out. The balanced funding option is recommended for those looking for assured returns after the end of tenure. It is also a valuable asset for someone having limited funds to invest in multiple sectors.

In the open ended segment also there are multi asset allocation and arbitrage funds. Having similar kind of investment strategy mentioned earlier.

Equity savings is an open ended scheme investing in a combination of equity (minimum 65 per cent), arbitrage and debt (minimum 10 per cent). The minimum investment in arbitrage is specified in the scheme objective.

Solution Oriented Schemes

1. Retirement fund: An open ended retirement solution oriented scheme having a lock-in of 5 years or till retirement age, whichever is earlier.
2. Children’s fund: An open ended fund for investment for children having a lock-in for at least 5 years or till the child attains age of majority, whichever is earlier.
3. Fund of funds is an open ended fund of fund scheme investing in an underlying fund. Such funds invest in mutual funds to generate returns. The minimum investment in the underlying funds shall be 95 per cent of total assets. Suitable for investors with relatively fewer resources and low liquidity needs can choose to invest in the top fund of funds available in the market. This enables them to earn maximum returns at minimal risk.

There are other schemes as well like index funds and exchange traded funds. The other options are real estate mutual funds schemes, real estate investment trusts (REITs) and infrastructure investment trust (InvIT).

Conclusion: The hybrid funds are a combination of growth generated from equity investments and stability provided by the debt instruments. Traditional investors who want to take moderate risk and earn above the fixed deposits can opt for hybrid funds.