Are hybrid mutual funds the future of tax-saving investments? Find out if they balance risk and return well

Hybrid mutual funds may replace debt funds after the abolition of indexation benefits. But, they carry greater risk due to higher equity exposure.

hybrid mutual funds
  • The Rs 7.85 trillion strong debt funds have lost their tax and indexation benefits from this financial year.
  • Hybrid fund sub-categories are seen as an alternative investment avenue.
  • Despite the tax advantage and growth prospect, hybrid funds can increase your equity exposure by 65% or more, increasing volatility risks.

With Rs 7.85 trillion in assets under its management, deb-oriented mutual funds constitute over 23% of the Rs 40.05 trillion Indian mutual fund industry. However, stakeholders of this fund category received a rude shock in March 2023. The long-term capital gain tax of 20% with indexation benefit has been abolished, allowing alternatives like hybrid funds to emerge into the conversation.

Recap on the debt fund taxation rule

Until the previous financial year, the redemption of a debt mutual fund held for three or more years was taxed at 20% after allowing indexation benefits. For someone in the 30% income tax slab, debt mutual funds offered a flat reduction of 10% in the tax rate. Besides, indexation increased the cost of acquisition by taking inflation into consideration. This reduced the capital gain, which further reduced the tax liability. All that tax benefit is now gone for debt funds with less than 35% investment in equity. In addition, debt funds are no longer the tax-saving poster boys of mutual funds in India. 

Also ReadDon’t miss out on these high-return alternatives if you are a debt mutual fund investor or HNI

The hybrid alternatives

Experts are pointing at funds that invest 35-65% in equities as the next best thing under the present taxation scenario. These funds are categorised as hybrid mutual funds and are treated as equity funds for tax purposes. Capital gains on these funds, after one year of holding, are charged at 10%. Gains up to Rs 1 lakh are exempt from tax.

Hybrid funds are further divided into six sub-categories, namely conservative hybrid funds, balanced or aggressive hybrid funds, balanced advantage funds, multi-asset allocation funds, arbitrage funds and equity saving funds.

Out of these categories, balanced hybrid funds will continue to be taxed in the same manner that was applicable to debt funds until the previous financial year. These funds invest 40-60% in equity and likewise in debt instruments. On the other hand, aggressive hybrid funds, arbitrage funds and other funds with at least 65% equity investment continue to be taxed like pure equity funds.

Pick your hybrid fund

  • Balanced advantage funds - There are around 30 hybrid funds presently active in India, and most of them maintain an equity allocation of 65-100% and debt investments of 0-35%. Balanced advantage funds are one such sub-category. Investment in these funds would increase the risk exposure and growth prospects while getting stability from the debt exposure.

Also Read: Balanced advantage fund: Get the best of equity and debt in a single fund with favourable taxation 

  • Equity savings funds and arbitrage funds Equity savings funds allocate funds between equity, debt and arbitrage opportunities. Within arbitrage opportunities, these funds exploit price differences in the cash and derivative segment of the equity market. This reduces the fund’s volatility. The debt allocation brings a steady income while the fund generates returns on the equity front.

Pure arbitrage funds have generated a low category average return of 4.96% and have no or minimal equity exposure.

  • Multi-asset allocation funds - These funds allocate between equity, debt and one more asset class, with at least 10% investment in each of the three categories. The risk gets diversified, but the fund may fall behind the market return as equity weightage is likely to be less compared to pure equity funds.

Also ReadAre you 50+ and retiring soon? This mutual fund category could be ideal for you

Are Hybrid mutual funds a safe bet?

Despite the tax benefits, hybrid funds are far more volatile than debt funds. The investment tenure for the two would differ widely, and the risk exposure will get altered too. Swapping debt funds for hybrid funds is suitable only for investors who are open to the increased market risk, and/or keep tax efficiency as a major consideration. It may also make sense to long-term investors as the increased risk of hybrid funds can be expected to even out in the long run. 

Disclaimer: This article is intended for general information purposes only and should not be construed as investment or legal advice. You should separately obtain independent advice when making decisions in these areas.


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