By Hemanth Gorur
Investors who are neither too risk-prone nor too risk-averse find themselves in a pickle when it comes to the type of mutual fund schemes they want to invest in. Equity funds offer high returns but entail higher risk, while debt funds can be stabler but offer lower returns.
One workaround is to invest in hybrid mutual fund schemes, which can offer a bit of both.
Hybrid MF schemes
A hybrid mutual fund scheme invests in both equity and debt securities. Investment in equity is for long-term wealth creation and superior returns. Investment in debt is for stability of portfolio and periodic income.
As per the Securities and Exchange Board of India (SEBI), there are six sub-categories under hybrid mutual fund schemes. Conservative hybrid fund is one of the main sub-categories. As the name suggests, the scheme invests conservatively by investing 75-90% of its total assets in debt securities, and the remaining in equity.
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Balanced hybrid or aggressive hybrid fund is the second sub-category, which invests 40-60% of its total assets in equity, and the remaining in debt. Aggressive hybrid fund invests 65-80% of its total assets in equity, with the remainder invested in debt.
Other sub-categories include the multi asset allocation fund, dynamic asset allocation fund, arbitrage fund, and equity savings fund, each with varying compositions of equity, debt, and other asset classes.
Then there is capital protection fund where a part of the principal is invested in debt securities whose maturity amount over the term of the fund would equal the principal amount. The remainder is invested in equity to fetch superior returns.
Risks in hybrid schemes
Fund schemes like arbitrage funds and equity savings funds are considered safer. While the former does away with risk by adopting arbitrage strategies to cover risk, the latter is a moderately low risk option as it invests in debt and arbitrage apart from equity.
Arbitrage fund schemes exploit price differentials in different markets to make a profit. They work well when there is volatility in the market, hence are ideal for investors who do not want to take too much risk yet profit from volatile markets.
Conservative hybrid funds offer moderate risk and eliminate much of the risk by concentrating on debt investments. Dynamic asset allocation fund schemes and multi asset allocation fund schemes have moderate risk as they comprise multiple assets and active management of the scheme’s portfolio. Balanced fund schemes entail moderately high risk as they include a significant chunk of equity investments but do not involve active churning of the allocation mix. Aggressive hybrid fund schemes offer higher returns but at higher risk as they invest predominantly in equity.
The alternative to investing in hybrid schemes is to invest separately in equity, debt, and other asset classes. Here, the investor would have more choice and more control over the asset allocation. The flipside is that the investor is saddled with more decisions to make.
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Hybrid schemes take away the tedium of decision-making. However, the investor needs to carefully study the scheme’s investment objective, asset allocation, investment strategy, and the fund manager profile, among other things, before choosing a scheme to invest in. All this information is provided in the scheme documents by the asset management company operating the mutual fund scheme. Shortlist schemes based on the alignment of their investment objective with your financial goals and risk appetite, and choose the ones whose asset allocation mix closely matches your target allocation and whose investment strategies you are comfortable with.
Do not forget to do your own research and study the scheme’s performance history before locking on to your dream mutual fund investment.
* There are six sub-categories under hybrid mutual fund schemes
* Hybrid schemes take away the tedium of decision-making
* Arbitrage funds and equity savings funds are considered safest while aggressive hybrid fund schemes have the highest risk
The writer is founder, Hermoneytalks.com