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Best Hybrid Funds

In the universe of mutual funds, there are three main types — equity, debt and balanced funds. These three types of mutual funds cater to different categories of investors, depending on risk appetite and investment goals. Of the three, balanced funds cater to investors who don’t want to take a high level of risk, but want higher returns. A balanced fund is a variety of hybrid fund that invests in multiple asset classes, typically equity and fixed income instruments. There are a variety of these funds available in the market; let’s take a look at how you can go about finding the best balanced mutual funds.

What we know as balanced funds in India invest in a mix of equity and debt, generally in the ratio of 60:40. Of course, there are many variations to this theme, and the top balanced mutual funds may follow different approaches. A top balanced fund with a conservative approach will probably invest less than 50% in equities, while a higher risk fund can invest up to 70% in equity. Needless to say, a balanced fund with a higher equity component will have more risk than one with higher debt. Finding the best balanced mutual funds for your needs will depend on your goals.

Types of balanced funds

  • Equity-oriented funds: There are many kinds of balanced funds, and the top balanced funds for you will depend on your choices. If a mutual fund invests a large proportion in equity, it’s called an equity-oriented fund and among the top balanced funds of choice for those willing to bear a higher amount of risk. If it invests a major portion in debt, it’s called a debt-oriented fund, and these types are among the best balanced mutual funds for the risk-averse. An equity-oriented fund will invest mostly in the shares of companies in various sectors like pharma, information technology, infrastructure, mining and so on. This kind of fund offers higher returns, but the corresponding risks are higher too.

  • Debt-oriented funds: A debt-oriented fund will focus more on fixed-income instruments like government securities, treasury bills, debentures by private companies and certificates of deposit. The risk here is lower, as are the returns. These are the best balanced mutual funds for those not prepared to take many risks.

  • Monthly income plan: A monthly income plan (MIP) invests over 80 percent of its funds in debt and the rest in equities. This enables investors to enjoy a regular income, while at the same time ensures they enjoy the benefits of the higher returns offered by the stock market. A MIP is the top balanced fund for someone who has retired or has no other sources of income.

  • Arbitrage fund: Another hybrid mutual fund is the arbitrage fund, which takes advantage of price differences between the derivatives and cash segments of the stock market. However, arbitrage opportunities are not available all the time, so to ensure steady returns to investors, these types of hybrid mutual funds place part of their corpus in fixed income instruments. This should be a top balanced fund for an investor prepared to take his chances.

  • Dynamic asset allocation fund: Another type of hybrid mutual fund is the dynamic asset allocation fund, which changes the mix of equity and debt in its portfolio according to the demands of the situation. Fund managers of top balanced mutual funds like these invest more in equity when prices are low and less when prices are on the higher side. This has the advantage of reducing volatility, making this kind of fund among the top balanced funds for risk-averse investors. Returns will depend on the skills of the fund manager and his ability to evaluate situations.

  • Multi-asset fund: This is a type of hybrid mutual fund that invests in a combination of assets, like equity, debt, and gold. These can be aggressive or conservative and the best balanced mutual funds in this category will depend on risk appetite. Aggressive funds of this type will invest most of their portfolio in equity and should be the top balanced fund for those who want higher returns and are willing to take more risks in order to achieve them.

Advantages of top balanced mutual funds

  • Balance risk and return: The biggest advantage of a top balanced mutual fund is that it allows investors to balance risk and return. The equity portion will earn better returns, and the debt part will earn steady returns at lower risk. Investors can also choose the mix of equity and debt that is suited for their needs. For example, an aggressive balanced fund will invest, say, over 75 percent in equities and the rest in debt. A conservative fund may invest less than 50 percent in equity.

  • Diversification: A top balanced fund offers investors the benefit of diversification since it combines both equity and debt. When share prices go down, the debt component in these kinds of hybrid mutual funds ensures stability. So top balanced funds are able to withstand shocks during a bear phase. Generally, debt and equity have an inverse correlation; they move in different directions. So a top balanced fund helps you hedge your bets. One thing you must remember is that balanced funds do not do as well when the market is on a bull run. Another point is that when share prices rise, fund managers will have to sell stocks in these kinds of funds to maintain the required equity-debt ratio.

  • Suited for first-time investors: Top balanced funds are especially suitable for first-time investors, especially in equity. They will get exposure to equity, but the risks are not too great when share prices rise and fall.

  • Systematic investment plan (SIP): Another advantage of a balanced fund is that you can invest small amounts each month in top balanced mutual funds through a SIP depending on how much you can save. Is there an advantage in investing small sums over a period of time? Some feel that it doesn’t matter whether you invest in a lump sum or in installments since you are investing mainly in debt. But it will matter if the balanced funds have a higher component of equity since you’re in danger of getting into the stock market when prices are high. In top balanced funds with a higher component of equity, it’s better to take the SIP route since you enjoy the benefit of rupee cost averaging.

  • Lower volatility: Equity funds are subject to the vagaries of the market. In a volatile market, investors could panic and opt out through redemptions. Having a debt component brings in a certain amount of stability to top balanced mutual funds, and fund managers will be able to handle redemptions better, ensuring stable returns to investors.

  • Higher returns: In some instances, the best balanced mutual funds have outperformed equity funds. Returns from top balanced mutual funds during the past few years have been higher than large-cap funds. This is particularly true in a volatile market.

  • Lower expenses: Since most balanced funds have a fixed proportion of stocks and bonds, and fund managers tend to place their bets on large-cap stocks, there is very little need for active portfolio management. Hence, expense ratios will be on the lower side for top balanced mutual funds.

Disadvantages of balanced funds

  • Risks: There is a misconception that the top balanced mutual funds are risk free. This is not true. There are two kinds of risk involved in a balanced or hybrid mutual fund – fluctuations in stock prices and interest rates. If stock prices fall, NAVs will drop according to the proportion of equity in the fund. Even the best balanced mutual funds are exposed to interest rate risk. When interest rates rise, NAVs will fall.

  • Less leeway for change: Balanced funds may not be ideal to meet changing investment goals. For example, if you want to reduce your exposure to equity, you will not have that option with a balanced mutual fund.

  • Difficult to compare: Another problem with hybrid funds that it’s difficult to compare returns of the best balanced mutual funds. In equity funds, for instance, you can compare the performance of your fund to an index like the Sensex, or specific indices like large cap, mid cap and small cap. You won’t be able to do this with a balanced fund. The only comparison you can make is with top balanced mutual funds in the same category.

  • Lack of focus: Managing debt and equity needs different skill sets, and managers of even top balanced funds may not have enough expertise in both fields, leading to sub-optimal returns for investors. You need to take a close look at the fund manager’s expertise and the track record of the top balanced funds before making any investments.

Tax treatment of balanced funds

Equity-oriented funds, with more than 65 percent in equities, have the same tax treatment as equity funds. If you hold them for less than a year, you pay 15 percent capital gains tax. Balanced mutual funds of this type held for over a year are eligible for long-term capital gains tax at 10 percent. Balanced mutual funds investing mainly in fixed income instruments are treated as debt funds. They are eligible for long-term capital gains tax of 20% with indexation if you hold them for three years and above. Any short-term gain is added to your income and tax according to your tax slab. Indexation reduces the amount you have to pay as tax, so you get that benefit.

How to choose the best balanced mutual funds

  • Risk appetite: Balanced funds have a mix of equity and debt in varying proportions. If you are able to bear a higher level of risk, the best balanced mutual funds for you would be those that have an equity component of 85 percent. If you want a moderate risk, the best balanced mutual funds would be those with an equity component of 60 percent. There are also schemes of hybrid mutual funds that cater to low-risk investors, with an equity component of 15-25 percent.

  • Monitor performance: The best way to monitor the performance of balanced funds and find the top balanced funds is by checking their returns over several years. The best balanced mutual funds would be those that have shown steady performance in bull and bear phases. You can download the Angel BEE app to monitor mutual fund performance and find top balanced mutual funds. Its ARQ hyper-intelligent investment engine helps you select the top balanced funds.

  • Expense ratio: The expense ratio is the amount charged by mutual funds to manage your investment. The best balanced mutual funds will probably have low expense ratios. Higher expense ratios will eat into your returns.

  • Time horizon: You have to hold top balanced funds for at least five years before you are able to realise the full benefit of these kinds of hybrid mutual funds.

  • Check the portfolio: As we have mentioned earlier find the best balanced mutual funds for you will depend on your investment goals and risk appetite. These funds invest a portion in equity. While some invest more in large cap companies, others may bet on mid cap and small cap stocks. Those that invest in small and mid cap shares may not be the top balanced funds of choice for conservative investors. The best balanced mutual funds for them would be those that had a large share in large cap shares.

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