Make Your Short-Term Money Count

Mutual funds are gradually emerging as an ideal investment vehicle to practice asset allocation for investors with varied risk and time horizon. Investors looking to invest in a combination of both debt and equity and/or generate regular income can choose the appropriate ones from wide varieties of hybrid funds. These funds allow investors to retain control on how much money should be invested into each of the asset classes during their defined time horizon so as to suit their risk profile and investment objectives. 

Hemant Rustagi
Chief Executive Officer, Wiseinvest Advisors 

However, choosing the right combination of hybrid funds can be a little tricky as there are six types of funds with a different asset mix. Here is a brief description of each category and what do they offer: 

Conservative hybrid funds: These funds invest around 75-90 per cent in debt instruments and the rest in equity. These funds can be a good option for investors looking to earn slightly higher returns than pure debt funds without taking too much additional risk. The minimum time horizon for investing in these funds should be 3 years. These are considered as debt funds for tax purposes-any capital gains on units redeemed within 3 years is considered as short-term capital gain and is taxed at one’s nominal tax rate. Any capital gain on units redeemed after 3 years is considered as long-term capital gain and taxed at 20 per cent after indexation. For investors opting to get regular income, dividend is tax-free in their hand. However, the fund pays a dividend distribution tax (DDT) of 29.12 per cent (including surcharge and cess). 

Balanced hybrid funds: There are two sub-categories here. First, there are funds that invest 40-60 per cent in debt securities and the rest in equities. These funds have the potential to provide higher returns than conservative hybrid funds, albeit with higher volatility. Then, there are aggressive hybrid funds that invest 65-80 per cent in equities and the rest in debt instruments. The ideal time horizon for investing in these funds would be 3-5 years and more. For tax purposes, these are considered as equity funds-capital gain on units redeemed within one year is taxed at 15 per cent and beyond one year is considered as long-term capital gains and taxed at 10 per cent. The DDT for equity-oriented funds is 10 per cent (plus surcharge and cess). 

Dynamic Asset allocation/Balanced advantage funds: Dynamic asset allocation funds manage allocation to different asset classes dynamically. Balanced advantage funds are those that usually invest in a combination of equity, arbitrage and debt in a manner that equity and arbitrage allocation is 65 per cent or more. These are ideal for investors who have a minimum time horizon of 3 years and are alright with higher risk as compared to balanced hybrid funds to earn higher pre and post-tax returns. 

Multi asset allocation funds: These funds invest in at least three asset classes with a minimum allocation of at least 10 per cent each in all three asset classes. These are ideal for those who may want some exposure to gold in addition to equity and debt. Most of these funds invest more than 65 per cent in equities and hence are treated as equity funds for taxation. Ideally, the time horizon should be the same as in the case of aggressive hybrid funds. 

Arbitrage funds: An arbitrage fund seeks to generate income through arbitrage opportunities emerging out of mispricing between the cash market and the derivates market. In other words, arbitrage funds capture the ‘interest’ element in the equity market and offer an opportunity for investors to earn healthy returns, without taking an equity market exposure. These funds invest in stocks and their futures simultaneously and hence, eliminate the risk of volatility normally associated with equity funds. Besides, arbitrage funds score over income funds in terms of tax efficiency as tax benefits of equity funds are applicable to these funds. 

Equity savings funds: Equity savings funds usually invest around 20-25 per cent in equities, 40-45 per cent in arbitrage and the rest in debt instruments. These funds can be a better option than conservative hybrid, both in terms of pre and post-tax returns. The ideal time horizon for investing in these funds would be 3 years or more.