Hybrid Mutual Funds It Is For A Mix Of Equity And Debt!

Equity mutual funds have the potential to provide high returns but they are for investors having a high risk appetite. If you are an investor looking for a mix of debt and equity, so that the risk element reduces by virtue of the presence of the debt element in the portfolio, hybrid mutual funds may just be want your looking for.  These funds carry both equity and debt component. There are two types of hybrid mutual funds. They include, Balanced funds and Monthly Income Plans (MIPs).

Balanced Funds

These funds cater to investors with a moderate risk appetite. The debt equity allocation is typically 65%:35%. Many funds invest at least 65% in equity and the rest in debt for income tax purposes.  The reason being, schemes having investment of above 65% in equity gets the tax treatment of an equity oriented mutual funds i.e. dividend income and capital gains are tax free after a year.

These funds invest the equity portion in stocks and the debt portion is invested in money market instruments, long term and short term bonds. The debt portion in the fund performs the task of protecting the downside and the equity portion works towards attaining growth. Thus the investor is able to invest in two asset classes simultaneously by purchasing one mutual fund scheme. This scheme is less risky than a pure equity oriented mutual fund. Some of balanced schemes include

• HDFC Balanced Fund
• ICICI Pru balanced Fund
• Sundaram BNP Paribas Balanced Fund
• Reliance Balanced Fund

Does it make sense to buy a balanced fund over a pure play debt or equity product?

Balanced funds have an added advantage over a pure play debt or pure play equity product as portfolio rebalancing is done by the fund manager at no additional cost. A pure play debt and equity product will require the investor to constantly monitor the portfolio, so as to ensure that the debt equity mix is maintained.

From a tax perspective too, a pure play debt product is taxed at a higher rate (short term gains are taxed based on the income tax slab of the investor and long term gains, are taxed at 10% without indexation or 20% with indexation whichever is lower) and hence the tax outflow will be higher while in a balanced fund, tax outflow will tend to be lower by virtue of the fact that balanced funds are taxed at rates applicable to an equity diversified scheme i.e. short term gains are taxed at 15% and long term gains are tax free

Who should opt for a balanced fund?

Investors with moderate risk appetite looking for growth of capital with downside protection during a market downturn should opt for a balanced fund. In order to benefit from the tax perspective, look for balanced funds that have an investment of at least 65% in equity. 

Monthly Income Plans

This scheme invests a small portion i.e. between 15% and 25% of the portfolio in equity and the balance in debt and money market instruments. This scheme is apt for those investors with a low risk appetite requiring regular stream of income. The large debt participation is aimed at attaining the goal of capital preservation and the equity portion is expected to provide the growth element to the portfolio.

The periodicity of the return depends upon the option chosen by the investor. These are generally monthly, quarterly, half-yearly and annual options. A growth option is also available, where the investors do not receive regular dividends, but gains in the form of capital appreciation.  

Short term gains on an MIP are taxed based on the income tax slab of the investor. Long term gains, are taxed at 10% without indexation or 20% with indexation whichever is lower.

The terminology Monthly income plan is deceptive and a lot or investors tend to think that this is an investment avenue offering assured monthly returns. Investors should note that there is no obligation on the fund to pay monthly income. The returns are entirely dependent on market performance. So there may be months where investors may not receive any income.

Some of the MIP plans in the market include

• HDFC Monthly Income Plan
• FT India Monthly Income Plan
• ICICI Prudential MIP
• Religare MIP

What makes an MIP attractive over a fixed deposit?

Income on fixed deposits i.e. interest is taxed on the basis of the tax bracket the individual falls in. So if the individual falls in the highest tax bracket, the tax quantum would be 33.99% taking into consideration the cess. However in case of an MIP, dividend distributed is subject to a dividend distribution tax in the hands of the mutual fund company which is ~14%.

Fixed deposits come with a lock in period while MIPs are open ended schemes and the investor can exit from the investment whenever it pleases him.

Over medium to long term period, MIPs tend to beat the rate of inflation on account of superior returns because of the equity element in the portfolio. Equities tend to perform well over the long term. On the other hand, returns on fixed deposits fail to beat the inflation rate but there is zero element of risk in fixed deposits while MIPs have a risk element because of equity exposure.

Who should opt for an MIP?

Investors looking to earn a higher return than fixed deposits and bonds by taking some amount of risk and also want a regular stream of income should opt for an MIP. It is an ideal investment product for medium to low risk investors.