Growing Your Wealth with Hybrid Funds | Hybrid Funds Explained

Sudden upward and downward movement of the equity market have made the equity investors worry about their wealth every time the market swings. Equity Mutual fund investors are equally affected by the sudden rising and falling of the equity markets as the equity funds (excluding hybrid funds) invest their whole capital into only stocks.

On the other hand, debt instrument investors feel they would have yielded more returns if they would have invested in the equity mutual funds when the stock markets rise and would be feeling relieved to realize they are not invested in the equities when the markets start correcting steeply and they are on a safe island with their debt mutual funds.

Won’t it be great if there exists a fund which would increase your equity exposure when the markets are low to reduce the cost average and simultaneously load up your debt segments when the equity markets are high to balance out the risk and rewards providing a intermediator advantage and keeps building your wealth with the best of both worlds… If you are still dreaming if such funds exist… let me tell you the good news that yes!! Such funds exist and goes by the name Hybrid funds.

What are hybrid funds?

Hybrid funds are the mutual funds that work on the concept of asset class allocation i.e., these mutual funds invest their capital in a combination of equity, gold, debt instruments, commodities, and other mutual fund ETFs. The primary advantage and the x-factor of these funds is that they provide investors to reap the benefits across various sectors and limit the loss by balancing out the downside due to the diversification done. Other advantage of such fund is they always provide a better risk to reward ratio compared to plain equity or debt funds.

Let’s understand that using an example

We are looking at the 2-year performance of the equity and debt markets. Assuming that the equity has an average return of 14% and debt market has return of 6% in 1st year. During second year… we assume markets have drastically corrected dropping the returns to just 6% in equity markets but debt markets outperform with a return of 8%.

While the equity and debt funds have 100% allocation in equity market and debt markets respectively. We have considered the hybrid funds with asset class allocation of 60% in equity and 40% in debt instruments. We can see the equity returned highest returns but there is always a risk of bear market where the wealth is wiped off in a matter of time but when we look at the debt funds, although the returns are increased in the second year but not to a level to outperform the equity funds. Hybrid funds gave the best returns overall considering the risk to returns ratio.

Types of Hybrid Funds

Hybrid category mutual funds comes in all forms and shapes, there are prominently 7 types of them. Let’s look at them one by one.

1. Aggressive Hybrid Funds

These mutual funds have the asset class allocation ranges from 65% to 80% in equity and 20% to 35% in debt and other asset classes. This is most popular and biggest type of hybrid fund as per the AUM across the mutual fund industry. This is best suited for an aggressive risk profile investor and with a high investment horizon.

2. Conservative Hybrid Funds

This type of hybrid funds must have the equity allocation between 10% and 25% whereas investments in debt and other asset classes should be between 75% to 90%. This is best suited for those investors who are not much of risktakers but would be happy with returns with slightly higher than FDs.

3.Balanced Hybrid Funds

These funds with the equity and debt fund allocation percentages will be similar. they generally range from 40% to 60% of equity and 40% to 60% of debt and other types. This is the second most popular hybrid funds in the investor’s circle because of its balanced allocation which is the most desired across the low-risk taker community.

4.DAF/BAF Hybrid funds

Dynamic Asset Fund or Balanced Advantaged Fund is a hybrid fund whose asset class allocation diversity is actively managed by the fund manager in no particular range of the equity and non-equity allocation. Based on the market performance and opportunities the fund manager balances the capital to gain the best returns possible. The beginner investors and the conservative investors who are looking for a well-diversified hybrid funds with a stable return would prefer this type of hybrid fund.

5.Equity Saving Hybrid Funds

Equity saving hybrid funds should maintain a minimum of 65% equity assets and 10% debt assets, but these are generally played safe by the fund managers by altering the equity and debt funds for better returns. This fund is best suitable for a moderate risk profile investors who want decent returns with somewhat risk and downside protection.

6.Multi Asset Allocation Funds

This hybrid fund will have multiple asset classes compared to other hybrid funds with a minimum allocation percentage of 10% across all the asset classes  . This can be considered as the most diversified hybrid mutual fund in terms of various types of asset classes. This fund is a tailor made for the pro investors who understand all the asset classes and their limitations and would prefer a stable return with slight risk.

7.Arbitrage hybrid funds

Arbitrage hybrid funds must maintain a minimum investment in equity and its related instruments of 65%. The name for this fund comes from the arbitrage gains that this fund generates based on the price difference across various markets for the same stock or instrument. This fund is used to park an Investor’s funds for about 6 months to 12 months.

Conclusion

Although hybrid funds are diversified across various asset classes, they would still have fair amount of equity allocation. We should note that the other asset classes apart from equity mostly help in hedging our fund when the equity part of the fund is in losses. So, one should thoroughly go through each type of the hybrid fund and carefully choose the correct type of hybrid fund as per their risk appetite. Overall hybrid funds are a great balancer between the risk and the return on investment.