What are Balance Mutual Fund and Hybrid Fund

Hybrid funds are mutual funds that invest in both Equity and Debt Market to provide good returns and are the perfect mixture of diversification. The asset allocation can vary depending on the requirement i.e. it could have high equity allocation, or balance of debt and equity depending the type of investor one is i.e. risk taker or a conservative investor.

A balanced fund is a form of the hybrid fund and suitable for first-time investors. They invest in multiple assets to protect the investor from volatility, if one asset class has some issues.   Investors who are not to open to take risk are best suited for investment in a balanced fund with present limitations of equity and debt allocation.

How do Hybrid Funds work?

Hybrid funds offer investors a diversified portfolio. They aim at achieving appreciation in long run and generate income in short run via a balanced portfolio. They maintain an investment ratio of 60% - 40 % in equity and debt instrument, with a majority in either of the two. If asset allocation is more than 65 % in equities, then it is equity oriented fund and if the 65 % is allocated to debt, then its debt oriented fund. To maintain liquidity, a part of the fund will also be invested in cash and cash equivalents. These funds are basically a platform for income generation and capital appreciation. The allocation of your money is done by the fund manager basis the objective of the fund and investor.  The fund manager will also sell/buy securities to take advantage of market movements.

Industries like FMCG, finance, healthcare, real estate, automobile, etc. provide equity shares which are part of the equity component of the fund.  The debt component of the fund contains investments in fixed income like government securities, debentures, bonds, treasury bills, etc.

 Who should invest in Hybrid Funds?

New mutual fund investors prefer the hybrid funds, since they are safer bets than pure equity funds. The debt component of the fund provides a cushion against a volatile market while providing decent returns which is best suitable for the conservative category of investors.  They provide higher returns than pure debts and new investors can always choose them as the first step. Since they have a blend of equity and debt, the equity component helps to ride the equity wave.

Types of Hybrid Funds:  They can be differentiated as per their asset allocation. There are different equity and debt allocation in different types of hybrid funds, some may have higher equity allocation and others may have high debt allocation. Below are more details on the types of hybrid funds.

Balanced Funds

Balance funds are one of the most common types of hybrid funds. The investment in balanced funds is done majorly in equity or equity-oriented investments. Balanced funds are a good bet for risk-averse investors. As balanced funds majorly invest in equity funds, they get the same tax treatment of equity funds. As per the updated rules of 2018, an LTCG (Long Term Capital Gains) tax of 10% is applicable if the capital gains of the investor are more than INR 1 lakh in a financial year

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 Monthly Income Plans

These funds mostly invest in debt instrument with around 15% to 20% exposure to equities. The reason behind equity exposure is to generate better returns than debt funds. Monthly income plans distribute income through dividends to investors. These plans also offer growth option to the investor.

Arbitrage Funds

Arbitrage funds use the advantage of the pricing difference of the securities in the derivatives and futures markets to generate good returns. However, the flip side is that the opportunities are not much and the funds will stay invested in equity or debt market. Arbitrage funds are treated as equity funds for taxation purpose and thus LTCG tax is also applicable to them.

Things Investor should consider before investing

 Risk

Even though hybrid funds have maximum percentage allocated to debt instruments, this does not mean they are not completely free from risk. There is still an equity component that is exposed to the market volatility.  Due to changing markets, the fund value fluctuates as per the underlying value of the benchmark. Although balanced funds are safer proposition than equity funds, an investor needs to exercise caution and rebalance portfolio regularly to gain maximum out of the investment.

Cost

Mutual fund houses charge an annual fee charged for managing the portfolio of the mutual funds which is known as the expense ratio. It is calculated as per the fund’s average assets. The expense ratio shows the operating efficiency of the funds and is an important criterion for investors, when choosing a mutual funds. It is a good idea to compare the expense ratio of funds falling in the same category. Lower expense ratio will translate into higher take-home returns for the investor.

Tax on Gains

Taxation on the balance funds works as per the orientation of the fund. The equity-based balanced funds get the same treatment of tax as a pure equity fund. If the investment in the equity-based balanced fund is more than a year, then it will be treated as long-term capital gain. Long-term capital gain (LTCG) in excess of INR 1 lakh on equity component will be taxed at the rate of 10% without the benefit of indexation. There is a tax rate of 15% on short-term capital gains of equity-based balanced funds.

Investment Horizon

Balanced funds are the best bet for the kinds of investors who would usually choose to invest only in bank fixed deposit for 5 years. Balanced funds have the potential to deliver higher returns than a bank fixed deposit in a 5 year or a higher duration of time. In addition, an investor will also get the benefit of indexation on the long-term capital gain.

 Financial Goals

Balanced funds are best for financial goals set for a period of 5 to 7 years. For example - a financial goal of buying a car or funding for the higher education. Balanced funds are also great for new investors or for people who do not have time to actively manage portfolio or have a low-risk appetite. Senior citizens or retired investors can choose to invest in balanced funds and use dividend option that will help in post-retirement income.

Return

Balanced funds are meant for investors who have a low-risk appetite. In the past, equity-based balanced funds have delivered average returns in the range of around 10% to 12%. Even though there is a component of debt in balanced funds, there is no surety on the returns. Depending on the performance of the securities, the NAV of the fund will fluctuate.