What Are Hybrid Funds? Meaning, Types & Key Considerations

A mutual fund does not always have to choose between equity and debt. Hybrid funds bring different asset classes into a single portfolio, combining equity, debt and where permitted by SEBI, InvITs and commodity related instruments. But the mix is not the same across all hybrid funds. Each category follows its own asset allocation and investment strategy, making the category, portfolio mix and investment mandate important when evaluating a hybrid fund.

Key Takeaways

• Hybrid funds invest across a combination of equity, debt, InvITs and commodity related instruments, as permitted by SEBI
• SEBI classifies hybrid funds into different categories, each with its own asset allocation and investment strategy
• The equity and debt exposure can vary significantly between categories, resulting in different portfolio characteristics
• Hybrid funds can provide exposure to multiple asset classes through a single mutual fund scheme
• Returns are market linked and depend on the performance of the underlying investments
• Before investing, compare the category, asset allocation, investment strategy, risk factors, portfolio and costs of the scheme

What are Hybrid Funds? 

A hybrid fund is a mutual fund scheme that invests across a mix of asset classes rather than following a single asset class. Under SEBI’s definition, hybrid schemes invest in equity, debt, InvITs and commodity related instruments, as permitted by SEBI. The mix can differ across categories and schemes, depending on the investment mandate.

This multi asset approach gives hybrid funds a distinct structure. Instead of relying entirely on the performance of one asset class, the portfolio can combine different sources of return and risk. The asset allocation is therefore central to understanding a hybrid fund, as it determines how much the scheme is exposed to equities, fixed income and other permitted investments.

Features of a Hybrid Fund

Hybrid funds are mutual fund schemes that invest in a combination of asset classes. The key features are:

1. Investment across asset classes

A hybrid scheme invests in a combination of asset classes rather than focusing exclusively on equity or debt. The specific combination depends on the scheme category and its mandate.

2. Category defined asset allocation

Each hybrid fund category has prescribed investment requirements. The allocation between equity, debt and other permitted investments therefore varies across categories.

3. Diversification within a scheme

By holding different asset classes, a hybrid fund can spread its portfolio exposure across investments with different characteristics. However, diversification does not eliminate investment risk.

4. Different equity and debt exposure

Hybrid funds can have substantially different levels of equity and debt exposure. This means their risk and return characteristics can vary significantly from one category to another.

5. Professional management

The scheme's investments are managed by the asset management company in accordance with the stated investment objective, asset allocation and applicable regulatory requirements.

6. Market linked returns

Hybrid fund returns are not fixed. The NAV can rise or fall depending on the performance and valuation of the securities and other instruments held by the scheme.

7. Category based investment framework

Hybrid fund categories are defined by their respective investment objectives and asset allocation requirements. The scheme's portfolio is constructed in accordance with the requirements applicable to that category.

8. Different portfolio compositions

Hybrid funds do not all follow the same asset allocation. The proportion invested in equity, debt and other permitted instruments varies across hybrid fund categories. Consequently, the underlying portfolio and associated investment risks can differ from one category to another.

How Does a Hybrid Mutual Fund Work?

A hybrid mutual fund pools money from investors and invests it across a combination of asset classes in accordance with the scheme's investment objective and the requirements applicable to its category. Under SEBI's current framework, a hybrid scheme is a mutual fund scheme investing in a mix of equity, debt, InvITs and commodity related instruments, as permitted by SEBI. 

• Investors contribute to the scheme: Investors purchase units of the mutual fund and the money collected forms part of the scheme's corpus.
• The corpus is invested according to the scheme mandate: The fund invests the corpus across the permitted asset classes based on the asset allocation applicable to that particular hybrid scheme. Different hybrid categories can therefore have different portfolio compositions. 
• The portfolio is managed by the fund manager: The fund management team selects and manages the investments within the scheme's stated investment objective, asset allocation and applicable regulatory framework.
• Portfolio value changes with the underlying investments: The value of the scheme's portfolio changes as the market value of its underlying investments changes. Factors affecting individual asset classes, such as equity prices, interest rates, credit conditions or commodity prices, can therefore affect the scheme's NAV.
• Investors receive the change in value through the NAV: The NAV of the scheme reflects the value of its assets after accounting for applicable liabilities and expenses. When investors redeem their units, the redemption proceeds are based on the applicable NAV, subject to the scheme's terms.

Types of Hybrid Mutual Funds

SEBI categorises hybrid mutual fund schemes based on their prescribed asset allocation and investment strategy. The seven categories are:

These categories differ primarily in their prescribed asset allocation and investment strategy. The specific portfolio of a scheme is therefore determined by the characteristics applicable to its category.

Who Should Consider Hybrid Funds?

Hybrid funds may be considered by investors who want exposure to multiple asset classes through a single mutual fund scheme. Since hybrid categories have different asset allocations and investment strategies, the suitability depends on the specific category rather than the label hybrid alone.

• Investors seeking equity and debt in one scheme: Conservative, Balanced and Aggressive Hybrid Funds combine equity and debt in different prescribed proportions.
• Investors seeking a particular equity debt mix: The prescribed allocation can help investors choose a category that aligns with the level of equity exposure they are looking for.
• Investors considering dynamic asset allocation: Dynamic Asset Allocation Funds or Balanced Advantage Funds manage their equity and debt allocation dynamically.
• Investors seeking exposure to multiple asset classes: Multi Asset Allocation Funds invest across at least three asset classes, subject to the applicable minimum allocation requirements.
• Investors looking for specific strategies: Arbitrage Funds and Equity Savings Funds follow distinct investment strategies and should be evaluated separately from other hybrid categories.

How to Invest in a Hybrid Mutual Fund?

Investing in a hybrid mutual fund is similar to investing in any other mutual fund. The main step is choosing a scheme whose mix of equity, debt and other permitted investments suits your investment needs.

1. Choose a hybrid fund category

Hybrid funds have different categories, such as Conservative Hybrid, Aggressive Hybrid, Balanced Advantage and Multi Asset Allocation. Their asset allocation differs.

2. Compare the schemes

Check the scheme's investment objective, asset allocation, risk factors, expenses and investment strategy.

3. Complete KYC

Make sure your KYC is completed before investing.

4. Choose Direct or Regular

You can invest through a Direct Plan or a Regular Plan. Their expense ratios can differ.

5. Choose lump sum or SIP

You can invest a one-time amount or invest regularly through a SIP, depending on the scheme's available facilities.

6. Select Growth or IDCW

Choose the available option based on how you want the investment to be structured.

7. Invest and review

Once invested, periodically review the scheme and its portfolio to ensure it continues to fit your investment objective.

Factors to Compare Before Picking a Hybrid Fund

Since hybrid funds can have very different portfolios, comparing the scheme's structure is important. Consider these factors before investing:

• Asset allocation: Check how much the scheme invests in equity, debt and other permitted asset classes. This is one of the biggest differences between hybrid categories.
• Investment objective and strategy: Understand what the scheme aims to achieve and how the fund manager intends to construct the portfolio.
• Risk level: Review the scheme's risk-o-meter and understand the risks associated with its underlying investments.
• Past performance: Compare performance across relevant periods and against the scheme's benchmark. Past performance does not indicate future returns.
• Portfolio composition: Look at the equity and debt holdings, concentration, sector exposure and credit quality, where relevant.
• Expense ratio: Compare the costs of similar schemes. A higher expense ratio can reduce the return retained by investors.
• Fund manager and fund house: Consider the fund manager's experience and the fund house's investment processes and track record.
• Investment horizon: Match the scheme with the period for which you expect to remain invested, based on its portfolio and investment strategy.

Conclusion

Hybrid funds combine different asset classes within a single mutual fund scheme, but the portfolio structure varies across categories. The allocation between equity, debt and other permitted investments determines how each category is constructed and how its portfolio is exposed to different market factors. Investors should therefore look beyond the hybrid label and evaluate the specific category, asset allocation, investment strategy, risk factors and costs before investing.

FAQs

1) What is a hybrid mutual fund and how does it work?

A hybrid mutual fund is a mutual fund scheme that invests in a combination of asset classes, including equity, debt, InvITs and commodity related instruments, as permitted by SEBI. The specific asset allocation depends on the hybrid fund category.

2) How many types of hybrid funds are there under SEBI's framework?

SEBI's hybrid fund categories include Conservative Hybrid Fund, Balanced Hybrid Fund, Aggressive Hybrid Fund, Dynamic Asset Allocation Fund or Balanced Advantage Fund, Multi Asset Allocation Fund, Arbitrage Fund and Equity Savings Fund.

3) Are hybrid funds suitable for first time investors?

A hybrid fund may be considered by a first time investor, but suitability depends on the specific category, asset allocation, investment objective, risk profile and investment horizon.

4) Do hybrid funds carry lower risk than equity funds?

The risk of a hybrid fund depends on its portfolio and investment strategy. A scheme with higher equity exposure can have greater exposure to equity market movements, while other hybrid categories may have different risk factors.

5) What are the risks of investing in a hybrid fund?

Hybrid funds can be exposed to risks associated with their underlying investments. These may include equity market risk, interest rate risk, credit risk, liquidity risk and other risks, depending on the scheme's portfolio and investment strategy.

Disclaimers

Investors may consult their Financial Advisors and/or Tax advisors before making any investment decision.

These materials are not intended for distribution to or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation.  The distribution of this document in certain jurisdictions may be restricted or totally prohibited and accordingly, persons who come into possession of this document are required to inform themselves about, and to observe, any such restrictions.

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