I look at the utility of hybrid funds as 'starter funds'. Any investor who is getting started should do so only with these funds for their long-term money.
There are five to six kinds of hybrid funds. The starter funds which investors should use are the ones which have a well-defined debt-equity allocation. There are primarily three such categories. First, there are funds which invest 25 per cent in equity and 75 per cent per cent in debt. Then there are funds which invest equally in both equity and debt. And finally, we have aggressive hybrid funds which invest around 75 per cent in equity and the remaining in fixed income. The rest of the hybrid categories can be safely ignored by retail investors.
These three categories are meant for investors who've had no prior exposure to market-linked investments. Historically, Indians have been fixed-income investors. They have a mindset of asking 'how much will I get?' when discussing investments. And the moment they hear that there is no fixed return in market-linked investments and that the value can go down substantially, they get scared.
For such investors, hybrid funds are very useful because of their ability to absorb volatility. They are great vehicles to acclimatize with mutual funds or any market-linked investments.
Let's talk about these three hybrid fund categories in detail.
Conservative hybrid funds invest a maximum of 25 per cent in equity and the remaining in fixed income. These are meant for very conservative investors or for the income seekers. They are fairly stable because the exposure in equity is small and therefore, they don't throw nasty surprises when stock markets decline. You can derive periodic income from them without a substantial loss in the principal. But it is important that you don't invest in lumpsum even in these funds. Despite their limited equity exposure, it is worthwhile to avoid the possibility of catching a market high.
Next comes Balanced funds which invest almost equally in equity and debt. They are a wonderful vehicle but unfortunately we don't have many such funds. Most of the funds in this category are Children or Retirement funds. But I find this category extremely promising because of their ability to rebalance and handle volatility. Also, in retirement, one easily gets uncomfortable with a big slide in the value of their investment. These funds help you there.
Lastly, Aggressive Hybrid are suitable for first-time investors who have a long investment horizon of 10-15 years and are still in the accumulation phase. After three years, as they get familiar with equity investing, they can move to multi-cap, mid-cap or small-cap funds.