Whether you’re a seasoned investor or exploring investment opportunities for the first time, you probably don’t need us to tell you about the importance of managing risk through diversification of your portfolio.
When it comes to diversification, there are several ways you can go about it. Rather than looking at diversification through a lens of different investment types, here we’re going to explore hybrid funds specifically. Why are they an ideal vehicle if you’re looking to diversify your portfolio?
What are hybrid funds?
As you might have guessed from their name, hybrid funds invest in both debt and equity-linked instruments. Hybrid funds themselves will typically be incredibly diverse and may invest in, among other things:
- Securities from both the public and private sector
- Treasury bills
Hybrid funds are typically classified by the instruments in which they have interests. However, they may also be classified based on exposure, risk, or the investment’s specific objectives.
The idea behind investing in various instruments is to bridge the gap between debt and equity funds while also taking advantage of market conditions and fluctuations. For example, if an asset class such as securities is available relatively cheaply, a hybrid fund may focus on investing in these as a means of maximising returns.
Although hybrid funds are a useful means of diversifying a portfolio, they’re also seen as more suitable for investors with a higher appetite for risk-seeking more lucrative returns. However, the risk attached will be different for each hybrid and is usually most dependent on their exposure to equity funds.
Understanding the different types of hybrid funds
There are several types of hybrid funds. Understanding what they are, the differences between them, and how they may benefit you as an investor is a vital part of making them work for you.
These funds focus predominantly on equity funds, typically with an equity exposure of at least 65%. Equity-orientated funds tend to focus on shareholdings in potentially lucrative sectors, including property, vehicle production, real estate, and finance. High volume but low margin sectors, such as FMCGs, are also sometimes popular for equity-orientated funds.
These funds focus predominantly on investing in debt securities, with an asset allocation towards the debt of around 60%. Debt-orientated funds typically invest in assets like government-issued securities, treasury bills, and bonds. To ensure liquidity across an investment portfolio, these funds also tend to invest in cash and what are known as cash equivalents.
Balanced funds are often thought of as “traditional” hybrid funds due to the different instruments in which they’re invested. Although called balanced funds, they will typically favour equity investments, with at least 65% of a balanced fund portfolio being allocated towards such instruments. The remaining portfolio is invested in things like debt securities and cash reserves. One of the significant advantages of balanced funds is that the fixed-income debt elements help balance the risk attached to equity-linked investments.
Monthly income plans
If you’re looking for investments that deliver a regular income, a hybrid fund that provides a monthly income plan is worth considering. With a focus on generating a steady income, these funds usually focus on investing in debt-orientated instruments, with asset allocation into equity-related instruments typically around 20% or even lower.
Some investment plans will allow you to choose the frequency at which you receive dividends, ideal if you’re looking to generate a passive income.
Although arbitrage opportunities are rare, some funds regularly lookout for these and take advantage of the chance presents themselves. However, the rest of the time, these funds will typically act in the same way as debt-orientated funds.
What you need to consider before investing in hybrids
Hybrids can seem like an attractive investment opportunity. Still, you must consider the following before going down this route and choosing a specific type of fund:
- The specific investment objectives of the fund and how this reflects your own investment goals.
- If the investment tenure will enable you to reach your objectives.
- Your risk appetite and how each type of fund approaches risk with this in mind.
- That the cost of hybrid fund units and any ongoing costs are affordable.
- The past performance of the hybrid funds you’re looking at.