What are hybrid funds?
Hybrid fund schemes are ones that invest in more than one asset class. These plans typically combine equity and debt, while some also include gold and REITs. The percentage of each asset class can vary and depends on the objective of the scheme and the fund manager’s view. What schemes can investors use to meet their fixed-income allocation as well as get better taxation?
Investors can consider using some of the following categories based on their risk appetite, but must consider their overall asset allocation before making investment decisions. These schemes give you allocation to debt but with equity taxation.
a) Aggressive hybrid fund: These schemes put between 65% and 80% of assets in equity with the balance in debt and money market instruments. Here, the fixed-income allocation is about 20-35% in most cases.
b) Balanced advantage or dynamic asset allocation fund: Invests in a mix of equity and debt depending on valuations and market conditions on a pre-decided internal investment model. They could have up to 35% in debt, though it could be lower than that threshold at times. c) Multi asset allocation fund: Invests a minimum of 10% in at least three asset classes — typically, equity, debt and gold and alters its allocation based on market conditions. Financial planners feel this will work well if it has equity taxation. d) Arbitrage fund: These funds simultaneously purchase stocks in the cash market and sell in the futures market to earn a spread and get equity taxation. They carry no credit risk.
e) Equity savings fund: Invests in equity, debt and arbitrage opportunities in the cash and derivative segments of the equity market, with the equity and arbitrage portion constituting 65% of the portfolio. The unhedged equity portion of portfolio is conservatively managed and could be between 10% and 25%.
How are such hybrid funds taxed? What is the tax advantage of a hybrid fund?
Hybrid funds are treated as equity funds for taxation. This means if held for less than a year, an investor pays short-term capital gains tax of 15%, while if held for more than a year, savers pay long-term capital gains tax of 10% only. Thus, an investor in high tax brackets gets allocation to fixed income by holding such funds but eventually pays a lower tax.
What is the benefit of investing in a hybrid fund?
One of the biggest advantages of a hybrid fund is that it gives automatic asset allocation and rebalancing benefits to investors. Retail investors can buy a single fund instead of buying two or multiple funds, which works well in the long term.
