INVESTMENT: Use hybrid funds for asset allocation

To be a successful investor, one has to follow a process that involves steps like having an investment plan in place, working out the right asset allocation and choosing the right investment option in terms of transparency, flexibility, tax benefits as well as ability to achieve investment goals over a defined time horizon.

One of the key steps in this process is working out an appropriate asset allocation. Apart from ensuring diversification in the portfolio, it helps in determining the kind of risk you are likely to take and the kind of returns you can expect from your portfolio.

However, if you find investing in line with your defined asset allocation a bit tricky, investing in hybrid funds can be a good way to do so. There are a variety of hybrid funds on offer from mutual funds and you can benefit from them in more than one way.

Sebi has categorised hybrid funds into six categories. These are, conservative hybrids (invest 10-25% in equity and the rest in debt instruments), balanced hybrid funds(invest 40-60% in equities and the rest in debt instruments) and aggressive hybrid funds (invest 65-80% in equities), dynamic asset allocations fund (where allocation to equity and debt is managed dynamically), multi-asset allocation funds (invest in at least three asset classes with a minimum exposure of 10 % to each one of them), arbitrage fund (follows arbitrage strategy) and equity savings funds (invest at least 65% of the assets are invested in equity and arbitrage).

Hybrid funds provide you with an easy way to invest money in a pre-decided asset mix. However, it is important to understand the tax benefits in terms of capital gains, as well as dividend distribution tax. Hybrid funds that invest 65% or more in equity and equity linked instruments (including arbitrage) offer tax benefits applicable to equity funds and all others are treated as debt funds.

In terms of asset allocation, if you want to restrict the exposure to equities to say between to 10-25%, conservative hybrid and equity savings funds fit the bill. Similarly, if you wish to have higher exposure to equities, you can either choose a balanced advantage fund or an aggressive hybrid fund. Then, there is an option to invest in an asset allocation fund that has the flexibility of making changes in the asset allocation depending upon the market conditions.

A cap on exposure to different asset classes in hybrid funds brings in a discipline that helps you maintain your asset allocation without having to worry about rebalancing it. In fact, this periodic rebalancing between different asset classes by fund managers to maintain the committed asset allocation is quite tax efficient as you would be liable to pay tax only when you redeem your investments.

Of course, there is a flip side too. The major drawback of hybrid funds is that you have to entrust the entire money to a single or a couple of fund houses. Considering that some of the fund houses may not have the required expertise to manage both equity and debt portfolios efficiently, the returns can suffer. Hence, you need to be a little careful while selecting the funds.

Besides, hybrid funds are limited by the fact that you may not benefit from different investment strategies and philosophies, such as in the case of funds investing in a single asset class. For example, if you decide to invest equity allocation into pure equity funds, there are a number of options like well diversified large-cap funds, mid-cap funds, multi-cap funds, opportunities fund, value funds, thematic fund and sector funds.

However, the benefits of investing in hybrid funds outweigh the negatives, especially if you are not so experienced and do not have the wherewithal to manage your portfolio actively. Over time, you can include other funds in the portfolio and expand your investment horizon.

The writer is CEO, Wiseinvest Advisors