The Hybrid Path to Riches

If equities are the drama queens of investing, with swings and high rewards, and debt funds are the calm monks, then hybrid funds are the diplomats: forever trying to keep the peace between the two. They promise investors the best of both worlds, the upside of equities and the cushion of bonds. Their purpose isn’t to win the race but to ensure the investor sleeps well at night. No wonder hybrid funds are a favourite of those who want steady wealth creation without heartburn. Yet, the landscape has become complex even since the capital markets regulator, Securities and Exchange Board of India (Sebi), in 2017 identified seven official hybrid fund categories. Now there is an entire galaxy of hybrid-like schemes that blend assets in creative, and sometimes confusing, ways. There are conservative hybrid funds that hold just 10–25% in equities, while aggressive ones go up to 65-80%. The more flexible balanced advantage or dynamic asset allocation funds (DAAFs) can swing from 0% to 100% equity depending on market conditions. Arbitrage funds sit at the low-risk end, while multi-asset funds add gold, silver, or even international exposure to the mix. There are many more such combinations. Innovation Creates Grey Zones Fund houses have found clever ways to innovate around Sebi’s definitions of hybrid funds. Fund of funds (FoFs), children’s plans, retirement schemes, and even global multi-asset products now work like hybrids, without being officially classified as such. “Hybrid-like products have mushroomed,” says Shaili Shah (CFA), Chief Growth Officer at Sky PI Financial Services. “Many FoFs and goal-based schemes behave just like hybrids, but they fall outside the seven Sebi-defined categories.” She warns that while innovation offers more choice, it also increases confusion. For instance, a children’s or retirement fund can have multiple plans—conservative, aggressive, fixed allocation, or dynamic—which could make it tricky to understand. “It’s not the label but the underlying allocation that defines risk,” she adds. Shah is clear about suitability too: “When the time to the goal is long, say seven to ten years, equities alone make more sense. But for three to five years, hybrid funds or hybrid strategies offer a better balance between risk and reward.” The Static and the Dynamic The heart of hybrid investing is the allocation engine, the way the fund shifts between equity and debt. Static hybrids keep fixed ratios: an aggressive hybrid may maintain a 70:30 split between equity and debt, while a conservative one can flip that ratio. Predictability is their virtue, though they may miss opportunities in a volatile market. Within hybrids, the most prominent ones are the DAAFs, or balanced advantage funds, for retail investors. Dynamic funds, especially balanced advantage and DAAFs, are more flexible. They tweak allocations based on valuation models, buying more equities when markets look cheap and trimming them as valuations rise. “Dynamic allocation strategies were built to reduce volatility and behavioural mistakes,” says Chintan Haria, Principal Investment Strategist at ICICI Prudential AMC. “But investors should remember: no two balanced advantage funds use the same model. The outcomes can vary widely depending on how aggressively each fund moves.” The 65% Equity Rule In hybrid investing, taxation revolves around a single number: 65% equity exposure. Funds with at least that much equity enjoy equity-style taxation—20% on short-term gains (under 12 months) and 12.5% on long-term gains (beyond `1.25 lakh). Anything below, and the fund is taxed like a debt fund, with gains added to income and taxed as per slab. Sunil Jhaveri, founder of MSJ MisterBond, simplifies the hybrid universe for retail investors. He says there are only two truly relevant segments—balanced advantage (or dynamic asset allocation) and multi-asset funds. Even the FoFs that follow these principles can work, but that’s a choice best made with an advisor. “BAF is like the aloo (potato), a staple. It buys low, sells high, and gives a smoother ride.” When Balance Blurs The variety within hybrids can create overlaps. Many investors hold multiple hybrids, say, an aggressive hybrid, a balanced advantage, and a children’s fund from different AMCs believing they’re diversifying. In reality, most own the same large-cap stocks, which means more concentration, not diversification. “The illusion of diversification is real,” says Shah. “Three hybrid funds can easily end up holding identical top-10 stocks. Investors must use portfolio overlap tools or work with a professional. Or, they multiply exposure, not safety.” Even labels can mislead. Conservative-sounding funds can carry credit risk in their debt portfolios. Retirement funds, for example, may hold large equity allocations early, exposing older investors to volatility. Handholding Investors For all their appeal, hybrids aren’t DIY (do it yourself) investments. “Every category has its importance, and hybrid too has its place,” says Sharad Tandon, Founder of Invest at Ease. “For retail investors with stable income and moderate risk appetite who can stay invested for more than 12 months up to two years, we usually recommend the balanced advantage category. It gives a smoother experience. For those who can take higher risk, aggressive hybrids fit better.” Tandon says portfolios must be customised. “A portfolio isn’t a random mix of products. It’s a blend tailored to risk, horizon, and circumstances.” Offering a practical asset allocation framework for retail investors, Haria adds, “In our view, retail investors can consider keeping 40–60% of their portfolio in hybrid funds as a foundation. Over that base, they can build exposure to other categories. Within hybrids, those looking for short-term parking options may prefer arbitrage or equity savings funds; long-term investors with a conservative tilt can consider balanced advantage funds; and those with a moderate risk appetite may opt for a mix of multi-asset and aggressive hybrid funds.” Sebi continues to tweak rules to ensure investors are protected and yet not suffocated. Its draft guidelines issued this year, for instance, even allow limited exposure to real estate investment trusts and infrastructure investment trust. A newer variant, ‘income with arbitrage fund of funds’, is now being marketed for short-term investors, combining debt funds and arbitrage in a FoF structure. “Hybrids are evolving, and so must investor understanding,” says Shah of Sky PI. In the end, hybrid investing isn’t just about balancing growth with safety but balancing trust with understanding.

The Hybrid Path to Riches

The hybrid fund space is evolving fast, and investors need to stay on top to ensure they are picking stability over risk.