20 types of mutual funds in India that you need to know about – Part 3
In this 4-part article series, we discuss the 20 main types of mutual funds available in India and whether you should be investing in them. The main classification of mutual funds is by asset class ( i.e. what assets they are investing in). In part 1 of the series we focused on the different types of equity mutual funds and in part 2 of the series we discussed the different types of debt funds. In part 3 of the series, we discuss hybrid funds, which investment in a mixture of debt and equity.
Hybrid mutual funds – an introduction
So far in this series we have discussed equity and debt funds. Most investors would do well by holding a mixture of these two asset classes. One option is to hold a bunch of individual funds, but the other is just to opt for a hybrid fund. Here the fund manager holds both equity and debt instruments. He/she can change the allocation between debt and equity while staying within the mandate of the fund. So with hybrids funds, you not only outsource the job of instrument selection but also that of asset allocation (choosing between asset classes).
The main classification of hybrid funds is based on whether they are equity-oriented (% of equity > 65%) or not since this has important implications for whether the hybrid fund is taxed as equity or debt funds. Another classification is whether the fund is a generic hybrid fund or has a specific objective.
14. Balanced Funds:
What they invest in:As the name suggests, balanced funds invest in a balance of equity and debt instruments. However in India, balanced funds typically refer to equity-oriented hybrid funds i.e. they invest greater than 65% in equities.
Should you be investing in them: There are two angles to consider while investing in balanced funds: 1) the investment angle and 2) the tax angle. First, the investment angle. As a mixture of equities and debt, balanced funds are most suited for investors who have a intermediate investment horizon (3-5 years). You can consider balanced funds even if you have a longer investment horizon but not enough risk appetite to go for an equities-only fund. Since it if often thought that first-time equity investors are quick to sell their equity portfolios if they coincidentally end up experiencing big losses before they see any big gains, hence balanced funds are the recommended choice for first-time investors with long investment horizons. The second angle for investing in balanced funds is the tax angle, more specifically the favourable taxation of the debt part of the investment. Currently for debt funds, short-term capital gain tax (STCG) equal to marginal tax rate is applicable if investment is held for less than 3 years. If a debt investment is held for more than 3 years than a long-term capital gain tax (LTCG) of 20% (after indexation) is applicable. However in the balanced fund, the debt components gets taxed like equities – STCG of 15% till 1 year and LTCG of 0 after that.
15. Monthly Income Plans (MIPs):
What they invest in: MIPs also invest in a balance of equity and debt instruments, however these are debt-oriented hybrid funds i.e. they invest less than 65% in equities typically between 5% and 30%. MIPs may be further sub-classified as conservative or aggressive with c. 20% equity exposure being a good dividing point.
Should you be investing in them: The obvious thing to say would be that MIPs are best suited for debt investors who are willing or able to take slightly more risk. However things are not so simple. The big problem with MIPs is the expense ratio (i.e. the fees that you pay to the fund every year to manage your investments). Typically the expense ratio of debt funds is lower than that of equity funds because of their lower expected return. However the problem with MIPs as they currently exist in India is that while the expected return is closer to debt funds (since that is the predominant investment), expense ratios are close to that of equity funds. Another issue is that the taxation angle works the other way compared to balanced funds – so you end up incurring debt-like taxation even on the equity component. As a result, we feel that instead of investing in MIPs, potential investors would be much better-off investing in debt and equity funds separately. This way they would pay lower expense ratio and incur favourable taxation on at least the equity component. A MIP-like mix of equities and debt is most suited for conservative investors with a 3-5 year investment horizon.
16. Speciality Funds:
What they invest in: These hybrid funds invest in equity and debt instruments but with a specific purpose which is usually clear from the name of the fund. The two kinds of speciality funds most common in India are retirement funds and child education plans.
Should you be investing in them: While speciality funds are supposed to help you invest for a specific purpose, currently the speciality funds in India do not have much to distinguish themselves from other hybrid funds. For instance there are no target dated funds for retirement. Also the expense ratio of speciality funds is usually on the the higher side (>2%). Hence investors may be better off using ordinary mutual funds together with the help of a financial advisor to plan for their goals.